Will the election change CSLR?

The sometime-controversial, Hayne Royal Commission-prompted, financial services Compensation Scheme of Last Resort (CSLR) could be broadened, should Labor prevail at the upcoming federal election.

Industry leaders say implementing the scheme is premature unless other structural issues are addressed across the financial services sector to support consumers to receive compensation should they suffer a loss as a result of the actions of members of the financial services sector.

Three bills tabled in October 2021, whose purpose was to establish a framework for the administration and management of the CSLR, never made it through Parliament before the Federal election was called, putting the scheme on the backburner.

In its current form, the CSLR would compensate consumers who have been found by the Australian Financial Complaints Authority (AFCA) to be victims of financial misconduct. This would only be in the event other compensation options have run dry, such as a payout under a professional indemnity (PI) insurance policy.

The proposed scheme would cover personal and general advice on financial products to retail clients, credit intermediation, securities dealing and credit provision. If Labor wins, the scheme could be extended to cover managed investment schemes (MIS). 

Labor has also criticised the Coalition for watering down the proposed maximum payout from $550,000 to the current proposed maximum of $150,000.

Collapsed financial services business Sterling Group’s Sterling Income fund is the poster child for failed MIS. According to consumer group CHOICE, which has organised an action group around this, 100 people lost $18.5 million through the disastrous investment. As it stands, the CSLR would not compensate these investors. Even if it did, any compensation would be capped at $150,000.     

Neil Younger, managing director at Fortnum Private Wealth, said a number of issues need to be resolved before the CSLR can be properly designed and implemented.

“It’s essential there’s a safety net that protects consumers where providers are unable to meet their obligations. But the question is why the pool is required in the first place. There’s been no testing of the quality of professional indemnity cover that sits against an AFSL.

Plus, it’s been increasingly difficult to maintain PI insurance and insurers have been dialling back benefit positions. That’s creating gaps in the market.

“Also, we’re seeing more small businesses with AFSLs emerging. There needs to be an assessment of their capacity to meet their obligations if, through the AFCA process, they receive a sizeable determination. Nothing has been done to address those two fundamental issues. We’re just assuming the problem exists and now we’ve got to solve the problem by funding it.”

Younger said fixing the PI problem needs to go beyond just ensuring cover limits are adequate to reimburse consumers who have achieved a successful action through AFCA.

“There has to be a minimum set of standards around the adequacy of PI insurance beyond the premium. There are some challenges in this space because if the insurers don’t like the risk, they won’t provide the cover. There needs to be a concerted effort to ensure appropriate coverage in the PI space, including looking at how new facilities can be opened up to service the financial planning sector.”

On the AFSL side, Younger said AFSL businesses need to demonstrate their capacity to meet their obligations.

“My concern is capital adequacy provisions are too light. Licensees have to show solvency but the limits are low.”

ClearView Wealth managing director, Simon Swanson, said the starting point for any scheme is to create a compensation mechanism that puts people back in the position they were in before they suffered financial misconduct.

“They should be able to return to the position they were in before receiving the advice or investing in the product that was the instrument for the misconduct. You have to tread gently and carefully around compensation schemes of last resort, as they can be extremely problematic. These schemes are important and the design must be properly thought through.”

As an example, the capital requirements are very low with managed investment schemes. So if something goes wrong, the scheme designers do not have much to lose. However consumers who invest in failed schemes have a lot to lose.

Consequently, Swanson agrees consideration needs to be made about the appropriate intersection between scheme participants’ capitalisation, professional indemnity insurance and a CSLR.

He said more broadly, policymakers and legislators need to take a smarter approach to the CSLR.

 “We would like to see the Government and regulators step back and take an integrated approach. This is a classic case of Australia having another regulation, which doesn’t dovetail neatly with other regulations.”

Importantly Swanson said the scheme must truly be a last resort after all other avenues have been exhausted.

“Then you deal with the moral hazard.” 

This arises if operators know they can rely on a CSLR and therefore are purposely not adequately capitalised and underinsured, in the knowledge the scheme will cover them if they are pursued through AFCA and receive an adverse ruling.

MONEY FOR NOTHING

The structure of the scheme’s funding model is one of its most controversial aspects. As it stands, the CSLR would be funded in its first year by a special levy imposed on the 10 largest AFCA member firms. Subsequently, all firms would be required to pay an annual levy, which would be capped at $250 million, with individual sub-sector contributions capped at $10 million.

The Financial Planning Association of Australia’s (FPA’s) head of policy, strategy and innovation, Benjamin Marshan, said the ideal CSLR funding model would be an administration charge that is shared across the whole financial services industry based on AFCA membership, with each sector paying a levy based on its risks.

“Over the years, it’s true some sectors have had issues with unpaid determinations from external dispute resolution schemes.

“Nevertheless, the levy should be based on the current risks around non-payment. Financial advice complaints taken to AFCA have dropped significantly and cases found in favour of the complainant are around only 30% of complaints that go through the process. So there is little evidence of unpaid determinations in financial advice since AFCA was founded.”

Younger concurs. He believes everyone in the financial services sector should fund the levy. “The burden disproportionately falls to financial advisers. That’s a problem because financial planning clients will ultimately end up paying for it, which exacerbates the high cost of advice.”

Founder and principal adviser at Wealtheon Financial Services, Kristopher Meuwissen, said administration costs for the CSLR should be borne by the Federal government if the scheme is going to be run by AFCA and overseen by ASIC. The plan is for the CSLR to be an

AFCA subsidiary.

“Then, the Government has oversight over any wastage and can ensure costs don’t blow out. The industry should only have to foot the bill for the unfunded component of any compensation scheme.

“It’s likely the CLSR in its current structure will further exacerbate the contraction of the financial advice sector. Sometimes it feels like we’re being administered out of a job and hit by regulation after regulation. The Government has a huge role to play in running these schemes and reducing the compliance burden on the advice sector.”

THE RIGHT STRUCTURE

In terms of structure, Marshan said it should have pools of compensation for any consumer who has not been compensated as a result of a complaint made and withheld through AFCA.

“One of the common areas where consumers go uncompensated is in relation to investments, in particular managed investment schemes. But the problem of failure to compensate can happen across the whole financial services sector, particularly when professional indemnity insurance doesn’t respond to a complaint due to it sitting in an excluded area.” 

He acknowledges in an ideal world, the financial services sector would set up the scheme.

“But in reality, this won’t happen, so you need the Federal government to step in and make it mandatory. But after that, it would be better once it is set up if it is left to the industry to run. 

“This will create the right tensions between making sure it is appropriately funded and ensuring all financial services entities do their part to ensure behaviours are improved through doing something about misconduct when it is seen, rather than turning a blind eye.

“Given we are talking about compensating consumers who have unpaid determinations through AFCA, it isn’t appropriate for the scheme awarding compensation to also be responsible for administering it.

“The FPA believes the scheme should be managed independently of AFCA, to ensure it operates fairly for the whole financial services industry.”

Despite the various frustrations across the financial advice sector in relation to it, the CSLR issue hasn’t been put to bed years after the Hayne Royal Commission recommended it. 

The Federal election means nothing is likely to move any time soon on the scheme, if it gets up at all.