Getting the terms of reference right an important first step for the financial system inquiry
The two previous reports into Australia’s financial system drove positive and fundamental change. Sir Keith Campbell’s 838-page report (1981) recommending a move from a fixed to a market-base currency exchange rate, permitting entry of foreign banks and deregulation of the banking sector spearheaded Australia’s quest to be a financial powerhouse in the Asia Pacific.
And when Stan Wallis AC handed over his 704-page report (1997) of the nation’s financial system, the three most important recommendations — the establishment of new regulators, consideration of mergers and acquisitions and recommendations concerning electronic commerce — further reinforced the robustness and competitiveness of our financial system.
Governance Institute has confidence that David Murray’s AO financial system inquiry could drive similar positive and fundamental change to the current system. However, it is important to recognise that the first step in that process will be ensuring the terms of reference are on target.
In our submission on the inquiry’s draft terms of reference, we made the point that they are for the most part sufficiently broad to provide for a review of key issues. For example, although the superannuation sector is not listed as a separate field of inquiry in the terms of reference, the expanding pool of savings through our legislated superannuation scheme and the contribution of that capital to the future requirements of Australians is such that the governance and prudential oversight of this sector must be considered as part of any inquiry into the financial system. We think that the draft terms of reference are sufficiently wide-ranging and comprehensive to provide for such consideration.
When it comes to considering the allocation of financial risk — one of the issues listed in the draft terms of reference — we noted that disclosure alone will not necessarily protect Australians from financial risks, because allocating financial risk at the consumer level is not identical to allocating financial risk at the investor level.
Disclosure is a foundation stone of our financial system, with some of the responsibility shifted to the investor or consumer. But consumers of financial products are not necessarily taking a risk for reward in the same way investors are. So we have to ask ourselves if disclosure is the best means available to offer protection in all instances.
Our Members are also of the strong view that disclosure won’t protect investors in class actions. Currently the majority of litigation funders are not licensed, nor are the law firms who act as promoters, yet funded class actions are an accepted mechanism for those seeking recompense from corporations. This is an unregulated industry where the interests of some can override the interests of many.
There are conflicts of interest in funded litigation. A promoter and/or law firm seeks out and creates an action to further its business, not necessarily the interests of the plaintiffs. Without adequate conflict management arrangements, litigation funders whose interests conflict with those of their clients are more likely to take advantage of those clients.
While a funder might promise to meet all adverse cost orders made in favour of the defendant, if the funder lacks the financial resources to meet those costs, the representative member of the class may have to. There is a clear incentive for class action promoters to instigate actions regardless of whether they believe they will be successful or otherwise and regardless of whether they have sufficient funds to meet costs should the action fail.
We also urged the inquiry to consider the model for corporate governance that has been so successful in changing practice and behaviour in listed companies to be applied to managed investment schemes and superannuation entities, which currently do not have similar levels of transparency in their governance arrangements. And of course the issue of short-termism in relation to financial markets and achieving long-term investment outcomes for Australians through superannuation is a serious problem that the inquiry needs to turn its attention to. After all, short-termism in financial markets is itself a systemic risk that requires consideration. How to tackle it securely and effectively is unresolved and it is too much to ask of this inquiry to come up with all the solutions. But they can ensure we start the discussion and put it firmly in our sights.