When it comes to Australia’s laws governing the financial services industry, they are about as clear as mud.
This lack of legal clarity has been a major contributor to the misconduct scandals that have shaken the public’s faith in the sector. In many cases the principles that our laws are meant to uphold have become so burdened with exceptions and qualifications that it is very difficult to interpret and apply the rules, and it is often even more difficult for the regulators to enforce them.
As one professional advisor recently lamented to us during our research into reforming the sector, “I struggle to interpret ‘honestly, efficiently and fairly’ and other formulations in the law.”
For example, under the law financial advisors have a duty to act in the “best interests” of their client when they provide personal advice. This was originally intended to operate as a broad principle, but subsequently became subject to an exemption called the “safe harbour provision” that provides a partial defence against claims that a financial advisor has failed to act in a client’s best interests.
The provision states that a financial advisor will satisfy the duty if the financial advisor has taken certain steps, including identifying the objectives, financial situation and needs of the client.
Although intended to make it easier for financial advisors to comply, the safe harbour provision has led to a “tick-the-box” approach to compliance that often excludes the necessary exercise of professional judgment to ensure that the advice is in fact in the best interests of the client.
It is why the Financial Services Royal Commission into misconduct has crucially recommended that the exemptions and qualifications that have crept into the law be eliminated as far as possible.
These legal complexities are compounded by the fact that consumer credit, financial products and services often involve predictions about the future that are hard to evaluate at the time the decision is made.
For example, what might be perceived by a consumer to be a good decision to borrow today might prove to be a bad decision in the future if the consumer experiences financial hardship as a result of a life crisis, like loss of employment or a health problem.
This poses a challenge to lenders and regulators in determining compliance with responsible lending obligations. The complexities were tellingly revealed in a recent Federal Court case brought (and lost) by the regulator against Westpac concerning the benchmarks the bank used in assessing loan applications and determining a borrower’s capacity to service a loan.
What then is the answer to simplifying the legal framework governing financial services and financial services entities in Australia?
Our new white paper on reforming the sector argues that we need to move beyond prescriptive, rules-based regulation towards a principles-based, outcomes-focused regulatory framework. Key to that is to recognise that the core objective of the financial services system, and the policy that regulates it, needs to be the customer’s financial wellbeing.
A framework like this would have a number of benefits.
It would encourage the relevant actors to collaborate in co-creating financial wellbeing. Simply protecting people from harmful conduct isn’t enough.
It would be adaptive and flexible and would accommodate rapid changes brought about by technology and innovation.
- Rules and regulations would be more easily amended and updated and could therefore be road-tested to ensure that they were fit for purpose.
A principles-based approach like this would mirror similar approaches in other jurisdictions, like the UK, but it would go one step further by tying outcomes more closely to financial wellbeing.
It would also subject financial service providers to a duty to consider financial wellbeing in performing their functions and providing their services. In particular, they should be required to consider the impact that a course of action would have, or would be reasonably likely to have, on the financial wellbeing of an individual.
A corollary to this is that financial service providers would be subject to a duty to notify customers of material risks (and ways to address them) where they had the information and technological means to do so.
The imposition of a duty to take financial wellbeing into account would require financial services providers to consider a broader range of factors in meeting their duties, including the duty to act in the best interests of clients and to engage in responsible lending. This would help them to apply their professional judgment— informed by standards of reasonableness—in place of the existing ‘tick-the-box’ approach. It would also help to protect vulnerable people.
In short, the laws and regulation of personal finance in Australia need to be guided by financial wellbeing as it applies at the individual customer.
Only in this way will we be able to operationalise and give substance to the standards of conduct that were at the heart of the recommendations of the Royal Commission.