Following the Royal Commission's recommendation, the Australian Treasury released a consultation paper just before Xmas 2019 on the proposed Compensation Scheme of Last Resort (CSLR) – a fund which will compensate clients of most financial services who win a compensation payment through AFCA or some other process.
Comments are required by 7 February 2020 – a short period at this time of the year when the potential impact on planning firms, investment managers, platforms, brokers and lenders is potentially huge.
How large might the CSLR be? The paper raises the same question and we discuss it below.
How will this affect you?
Well, as in so many other aspects of financial services – you’ll be paying. And the cost could be substantial. The paper points out that “the highest contributor to the historical value of unpaid determinations has been those associated with financial advice” and that there are other schemes that apply to some extent to APRA regulated bodies, ASX members or superannuation fund members.
The paper is relatively short and worth reading in its entirety – download it here. We have briefly summarised the key issues below and invite your comments here.
We will use your comments to frame IMAP’s submission.
Our submission will be from the point of view of those who operate managed account programs of all sorts and those who advise on them.
Who does the CSLR cover?
Treasury suggest options of coverage of
- Advice clients only, or
- Any client of an adviser, investment scheme, broker, derivatives dealer or lender, but not APRA regulated activities, or
- Any member of AFCA – which would include APRA regulated organisations
We can expect the banks and insurers to strongly oppose the last option, not least on the grounds that they have a demonstrated ability to pay compensation from their own resources.
How should the CSLR be funded?
Treasury canvas a couple of options. None of them seem practical to us at first reading
- The levy might reflect an organisation’s or sector's likelihood of failing to pay any compensation awarded against it and Is there any way of assessing an organisations “risk”?
- The levy might be based on the ability to pay and if so how would you compare, for example advice businesses against funds management against derivative trading?
How would a rare, catastrophic loss be funded?
In the event of a single very large failure or a number over a period which far exceed the CSLR capacity, how will payments be made? Although Treasury suggest that recent uncompensated losses have averaged $5m p.a. and consequently a small pool might be adequate, failures in recent memory include;
Storm client losses probably exceeded $100m part funded by the bank lenders
BBY client losses are probably in excess of $21m
Kingsway Fund losses were nearly $40m
Treasury suggestions of how to meet large claims include:
A special levy on the uninvolved survivor organisations; or
Building up a bigger buffer than expected through higher ongoing levies; or
Borrowing after the event and then charging higher ongoing levies
Should there be a cap on compensation?
Should there be a cap on levies?
Should the CSLR provide compensation for legal costs?
In addition, there are questions that the paper does not address !
- Should compensation be available to all types of person and small business? AFCA defines its eligible complainants as “consumers” without any of the distinction between retail and wholesale which the Corporations Act considers?
- Does the existence of such a scheme create different incentives for consumers? A Moral hazard!
- Will the existence of the CSLR change the behaviour of AFCA? Would the compensation paid in the case of Storm say have been funded differently if the CSLR had been in existence and allowed for much more rapid payments than was in fact the case?
We should expect that there will be strong submissions from larger, APRA regulated institutions, presumably aimed at reducing their liability. Perhaps this is not unreasonable given their considerable recent and ongoing experience in paying compensation.
IMAP will be making its submission from the perspective of those who provide retail advice and those who provide services to those client through managed accounts. Your contribution is valuable.
Time is short so please have any submissions lodged here by 1 February 2020.
Any queries contact Toby Potter on 0414 443 236 or toby.potter@imap.asn.au