Higher prices at one stop EDR shop

The Government has opted to go with a ‘one stop shop’ approach to financial services external dispute resolution, but there is the real prospect of higher costs being imposed on financial planning firms, Mike Taylor writes.

High up amid the array of changes needing to be accommodated by the financial planning industry over the next two years is the implementation of the Government’s external dispute resolution (EDR) arrangements under the Australian Financial Complaints Authority (AFCA).

It is a measure of where reform of financial services EDR stands on the Government’s policy agenda, that the Minister for Revenue and Financial Services, Kelly O’Dwyer chose to announce the make-up of the AFCA during her address to last month’s Financial Services Council (FSC) Leader’s Summit in Sydney together with the further empowering of the Ramsay Review to scope out a last resort compensation scheme.

In truth, the Government’s announcement about the EDR changes and the formation of the AFCA could be interpreted as necessary policy house-cleaning; as being seen to be doing something about financial services consumer protection amid the almost endless stream of negative publicity surrounding the banks, financial planners and insurers.

In establishing the AFCA the Government has gone along with the recommendations of the Ramsay Review and effectively opted for a one-stop-shop arrangement for financial services complaints resolution – encompassing the Financial Ombudsman Services (FOS), the

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Credit Industry Ombudsman (CIO), and the Superannuation Complaints Tribunal (SCT) under a single umbrella.

However, if O’Dwyer had chosen to be entirely frank when addressing the FSC Leader’s Summit, she might have mentioned that what the Government had chosen to deliver was very much in line with what the industry had been discussing 10 years earlier, in 2007.

She might have mentioned the work done by the Productivity Commission (PC) in 2007 which traversed almost exactly the same issues as the Ramsay Review’s 2016/17 inquiry which has resulted in the formation of AFCA.

Then, as now, the notion of creating a one-stop-shop for financial services complaints had its champions and its detractors, with the CIO being foremost in sounding a note of caution about such a move.

Then, as in 2016/17, it was the Australian Securities and Investments Commission (ASIC) and FOS’ predecessor body, the Financial Industry Complaints Service (FICS) who were most strongly in favour of the formation of an umbrella body.

The 2007 exercise played its role in the formation of FOS from FICS and the Banking and Financial Services Ombudsman, the current changes can therefore be seen as a further consolidation and an expansion of the underlying architecture.

The Government’s contemplation of a compensation scheme of last resort can be seen as a recognition of the failings of the current EDR regime and the reality that many FOS determinations have actually failed to result in consumers being compensated.

According to the most recent data available from FOS, at the beginning of this year there were 35 financial services providers (FSPs) who are unwilling or unable to comply with 143 determinations, affecting 203 consumers.

It said that in 105 of these determinations, the consumer received no payments at all, despite the requirement on AFSL holders to have ‘adequate compensation arrangements’ in place.

It said of the remaining 38 determinations, partial payment to consumers was usually the proceeds of insolvency proceedings and represented a minimal return on the dollar, adding that “as a result of this non-compliance, $13,014,641.86 has not been returned to affected consumers”.

“This figure does not include any interest awarded on the base award by the ombudsman, nor does it include any adjustments for inflation over time,” the FOS announcement said.

Little wonder then, that in her address to the FSC O’Dwyer saw the necessity of mentioning that the Ramsay Review panel had been tasked with considering “the establishment, merits and potential design of a compensation scheme of last resort”.

The minister said the establishment of such a scheme would be “considered along with the merits and issues involved in providing access to redress for past disputes”.

“These are both important issues,” she said. “Firstly, it’s important to consumers who have wrongfully suffered loss and been awarded compensation, but have not received that compensation due to the insolvency of the financial services provider.

“Secondly, it’s important to consumers who, for a variety of reasons, have not had access to external dispute resolution for past cases.”

“If left unaddressed, these issues will further undermine trust and confidence in the financial system,” she said.

What O’Dwyer might also have mentioned, however, is that while the regulatory arrangements underpinning the formation of AFCA are not yet complete, it is the financial services industry which will be footing most of the bill for the new arrangements.

Just as industry funding arrangements are being put in place with respect to ASIC, the same will apply with respect to AFCA.

When this cost is put together with those associated with running a last resort compensation scheme, the financial services sector has plenty to be concerned about.

Foreseeing the problem, the FSC earlier this year retained the services of Canberra firm, Cadence Economics and emerged with findings which stated that the economic impact and cost to consumers of a financial services compensation scheme of last resort was being “perilously under-estimated by policy makers”.

“Conservative modelling by Cadence Economics estimates a scheme covering financial advice only would cost more than $100 million annually,” it said. “This equates to an annual cost of $4,549 per financial planner, or $28,354 per Australian Financial Services License (AFSL) authorised to provide advice to retail clients (advice licensees).”

It said scheme costs would rise to $310 million if the scheme was extended to cover product failures. 

“Further the modelling also shows that additional deadweight losses to the economy will accrue to the tune of 47 cents for every $1 paid in compensation. These additional losses would shrink investment and jobs in the economy.”

O’Dwyer gave a nod to the Cadence Economics findings in her speech to the FSC, saying the Ramsay panel would take this research into consideration in making recommendations to Government.

The Financial Planning Association (FPA) has also expressed its concerns about the costs and implications of implementing a compensation scheme of last resort, not least the danger that the bulk of costs would be carried by the financial planning industry.

In a submission filed with the Treasury in early July, the FPA urged consideration of an approach which also took into account product manufacture and distribution.

“Consumer protection and appropriate consumer compensation is the responsibility of all participants who have a role in causing, or an influence in allowing, consumer detriment,” it said.

“Until the regulatory and compensation framework is set to make each provider individually responsible and financially accountable to the end consumer for the provider’s legal and ethical obligations, the FPA is unable to support the introduction of a compensation scheme of last resort (CSLR),” the FPA submission said.

“Although the FPA understands the reasons for some stakeholders wanting to introduce a CSLR, we recommend that further analysis or inquiry is conducted as to why there are unpaid Financial Services Ombudsman determinations, before bolting on a costly scheme that does not actually address the underlying reasons as to why there are unpaid determinations.”

PI insurance – valuable or farce?

The Government’s acknowledgement of the probable value of a compensation scheme of last resort is owed to a general agreement that the current professional indemnity insurance regime is falling short of consumer expectations.ASIC told Senate Estimates in late July that this is because PI insurance (PII) was never intended to be an answer to consumer compensation issues.

“ASIC and others including industry associations, FOS and consumer groups have raised the shortcomings of PII as a compensation and consumer protection mechanism in a number of government inquiries and reviews including the [Financial System Inquiry] FSI,” the regulator told the Senate.

“PII is designed to protect licensees against business risk, not to provide compensation directly to investors and financial consumers. It is a means of reducing the risk that a licensee cannot pay claims because of insufficient financial resources, but has some significant limitations, including where there are insolvency issues or multiple claims against a single licensee,” ASIC said.

“Also, insurers who provide PII cover operate on a commercial basis, giving rise to issues including practical availability.”

“ASIC does not ‘approve’ PII arrangements and does not require evidence of annual or other periodic renewal of PII cover. We do, however consider AFS licence applicants’ PII arrangements (at the time of the license application), conduct surveillance on licensees as risk warrants, and maintain a dialogue with stakeholders regarding any issues that might give rise to regulatory risk that licensees may not hold adequate PII.”

In other words, the regulator believes PI insurance is only a partial answer with respect to consumer compensation and is something which will fall far short of last resort arrangements.

The Financial Planning Association also has its reservations about PI insurance.

“We agree that there are significant limitations in using professional indemnity insurance as a compensation mechanism, including:

The total funds available under a policy may not cover all of the compensation awarded against the insured;

The policy may not cover the conduct which gave rise to the order for compensation (for example, fraud);

The amount of compensation payable may be less than the policy’s excess; and

Cover may not have been taken out at all and self-certification often means this is only discovered after the firm is insolvent.

“To address these issues, we recommend that the regulator take a more active approach in ensuring that providers have appropriate PI cover in place,” the FPA said. “Where cover in inadequate, providers should be required to upgrade their cover or build liquidity to meet their compensation liabilities.”

“One model for building liquidity is to require each licensee to build liquidity to cover a multiple of the excess under their PI insurance. It may be appropriate to allow existing licensees longer to build up the required liquidity.”

“Further, licensees would need to publicly disclose where they haven’t yet reached the prescribed threshold.”

EDR not so super

Despite the almost universal opposition of the superannuation industry, the Government has opted to rope the SCT into the AFCA.

The almost universal opposition of the superannuation industry was based upon its concern that the SCT had been expressly established to meet the needs of the superannuation industry; and that it was covered by its own legislation – the Superannuation (Resolution of Complaints) Act 1993.

In a rare exhibition of unanimity, both the retail and industry funds sectors were unanimous in arguing for the retention of the SCT, largely in its current form but the Government chose to go with the recommendations of the Ramsay Review that it become a part of the AFCA.

Ironically, even after it is folded into the AFCA the nature and requirements of the superannuation industry mean that superannuation disputes will still need to be handled differently.

The Ramsay Review recommendations recognised the special nature of superannuation disputes and the workings of the SCT, noting unlimited monetary jurisdiction; a broad jurisdiction to review trustee decisions; and statutory provisions (such as the ability to join third

parties to a dispute and to require the production of information) to deal with the added complexity of some superannuation disputes.

The Ramsay Review’s recommendations were significantly coloured by the fact that the SCT had developed a significant backlog of cases and that this was owed, in large part, to resourcing issues.

The review noted that the while the SCT is an independent statutory tribunal, it was reliant on ASIC to provide staff and facilities to enable it to perform its functions.

“As [the] SCT does not have a corporate legal identity, in practice, this means that ASIC enters into all contracts on behalf of SCT and makes all payments, including staff salaries, payments to tribunal members, third party providers or to ASIC (for rent and corporate services ASIC provides). Staff of SCT are ASIC employees, employed under the ASIC Enterprise Agreement and SCT is co-located in ASIC’s Melbourne office,” it said.

In drawing its final conclusions, the Ramsay Review said it was of the view “that the current arrangements result in a lack of flexibility in funding and insufficient funding transparency”.

“The structure of SCT, set in statute, has not kept pace with modern governance arrangements and there is limited flexibility to select the most appropriate dispute resolution process,” it said. “The current arrangements have resulted in significant and unacceptable delays in the resolution of superannuation disputes.”

It said superannuation dispute resolution required more flexible, responsive and transparent funding mechanisms adding the current arrangements would also benefit from modernised governance arrangements and more flexible processes for resolving disputes”.

The SCT has sought additional funding from the Government to enable it to complete its existing workload before folding into AFCA.