Non-institutionally aligned financial advisers could pay proportionally more than other financial services industry participants – including super funds and banks – towards the government’s new Compensation Scheme of Last Resort (CSLR) if proposed risk metrics are taken into account.
The government wants the scheme to cover the broader financial services industry, but notes in a recent Treasury paper that 90 per cent of unpaid compensation claims stem from financial planning. The discussion paper goes on to propose that one way for CSLR funding to be determined could be according to risk metrics.
According to the 2017 Ramsay Review, which first proposed the scheme and the latest Treasury paper references, most claims usually stem from smaller advice firms that have become insolvent or experienced “significant cash flow issues”.
As it stands, the CSLR will likely be extended to cover superannuation funds and banks, despite the Ramsay review’s recommendation that it be initially limited to financial advisers.
“The CSLR will be industry-funded, operated by AFCA, extend beyond personal advice failures and have design features consistent with the recommendations of the Ramsay Review,” the Treasury paper entitled ‘Implementing Royal Commission Recommendation 7.1 – Establishing a Compensation Scheme of Last Resort’, states.
According to Jonathan Steffanoni from consultancy firm QMV, institutions like banks and super funds rarely go broke and are expected to push back against paying a disproportionate amount to cover the unpaid compensation stemming from advice.
The issue could become a “major bone of contention”, Steffanoni says.
“Super funds aren’t really leveraged, so the prospect of them being insolvent is almost impossible,” Steffanoni says, adding that Part 23 of the SIS Act already includes a provision for funds that have lost money due to fraud or theft.
In the unlikely event that a large bank looked like going belly-up, Steffanoni explains, the government would take the reigns as per its 2011 resolution powers, which were put forward by the Financial Stability Board in the wake of the GFC.
As seen during the Hayne royal commission, the institutions have pockets deep enough to pay their own compensation claims. The collective bill stands at around $2 billion so far.
If the institutions are successful in arguing – as Steffanoni suggests they may do in their submissions to Treasury – that they shouldn’t be involved, that will leave the bulk of the compensation costs to advisers.
Another outcome put forward by Treasury could be that institutions are included in the scheme, but a risk metric is applied so that advisers pay proportionally more. Treasury noted in the discussion paper, however, the complexity of assessing insolvency risk and the expense burden for smaller firms.
“It is possible that the levy imposed could be unaffordable for some smaller financial firms, given the likely correlation between risk and financial firm size, leading to increased costs for consumers and potentially reduced competition for those financial services,” the paper states.
The issue, then, may come back to whether institutions are included in the CSLR at all. Here, the paper puts forward three scenarios.
A “narrow-coverage” approach, as suggested by the Ramsay Review, would include financial advice only, while a “mid-coverage” approach would also include broking, investment services and credit provision. A “broad-based” approach, which the government is plumping for and was applied successfully in the UK, would apply to all licensed financial services entities.
The paper outlines the benefits of a broader approach, which include “greater protections and clarity for consumers”, plus “enhanced sustainability, as large and unexpected claims costs can be met by a wider range of members”.
Treasury is aware, however, that a push-back from the institutions is on the cards.
“Criticisms of the broad-coverage approach could include that it requires prudentially regulated financial firms to contribute to the CSLR when the risk of a determination relating to these services being unpaid is low,” the paper states.
According to Steffanoni, a unified push-back is a distinct possibility if the institutions are resolute in defying their inclusion in the scheme.
“There’s likely to be significant concern from the superannuation funds about the prospect of cross-compensation,” he says.
Submissions from stakeholders on the formation of the CSLR are open on the Treasury website are open until the 8th of February.