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Shifting sands in the regulation of financial risk

At the core of financial services law is the concept of risk.

In a new background paper – ‘Risk and Reform in Australian Financial Services Law’ (FSL5) – the Australian Law Reform Commission explores how an evolution in thinking about risk has been an important driver of financial services law reform, and draws lessons that can inform further reforms.

This article provides an overview of key themes arising from that background paper.

The context for shifting approaches to the regulation of financial risk

Two broad changes have emerged over time and provide the backdrop for much of the evolution in regulatory responses to financial risk:

  • First, there has been a ‘risk shift’, in which individual citizens have increasingly borne a greater degree of risk. For example, superannuation subject to financial market risks has increasingly replaced defined-benefit plans, in which those risks were borne by government or employers.
  • Second, there has been ‘financialisation’ of the Australian economy, involving increasing exposure to financial assets and markets and continuing growth of the financial sector. The total wealth of financial assets owned by Australian households is now in excess of $6.2 trillion.

These trends have meant that financial risks pose a greater threat to both the wellbeing of individual citizens and the Australian economy. These trends have served to underscore the public interest in regulatory intervention to address risks.

The story told by regulatory intervention is not a consistent one. Amendments over time have reflected different approaches to risk. While the story is not a linear one, to the extent there has been a theme, it is this: there has been a move away from a philosophy of ‘buyer beware’ and towards an approach that is less tolerant of risk.

How shifting approaches to financial risk are reflected in our law

The Corporations Act’s regulation of financial products and services has been premised on disclosure. Disclosure of information was presumed to be sufficient to “enable a consumer to make an informed decision relating to the financial product” (as the Wallis Inquiry observed).1 To this day, disclosure enjoys pride of place in financial regulation, reflected in the more than 45,000 words instituting its various requirements in the Corporations Act alone.

However, very soon after the commencement of the Corporation Act, the inadequacy of disclosure began to be recognised. In an Explanatory Statement accompanying amendments in 2005, it was observed that the average retail investor found it “difficult to absorb the large volume of information” in product disclosure documents, and was therefore “deterred from using the information to make investment decisions”.2

As a result of this, Australia’s approach to financial regulation began to change. A key turning point came with the publication of the Murray Inquiry in 2014. Murray was concerned that “consumers are taking risks they might not have taken if they were well informed or better advised”.3 A more interventionist approach followed, including Murray’s recommendations (which subsequently became law) that:

  • Financial firms should be subject to ‘design and distribution’ obligations, designed to ensure that financial products only end up in the hands of consumers for whom they are suitable; and
  • The Australian Securities and Investments Commission should be granted ‘product intervention powers’ enabling it to ban or impose conditions on the sale of certain financial products.

This story, of increasing intervention, intolerance of risk, and a move away from reliance on individuals to decide for and protect themselves, is also reflected in numerous other regulatory initiatives introduced since the commencement of the Corporations Act in 2001.

Why our existing legislation has proved inadequate

Financial services law has undergone significant change over the past 20 years. Notably, when it commenced in 2001, the Corporations Act was (a comparatively slight) 1866 pages long. It has since ballooned to in excess of 3900 pages, and a commensurate increase in size is also seen in its accompanying regulations and other legislative instruments.

The daunting volume of law is cause for concern, but even more concerning is its “Byzantine complexity’ (as described by former High Court Chief Justice Sir Anthony Mason).4 In particular, complexity has arisen because new law has simply been added to the old. The accretion of law has reflected varied approaches to risk, but there has been little desire to revisit or dismantle what came before.

The ALRC considers that a survey of our law highlights two particular needs:

  • First, the need for comprehensive and ongoing review of the law, to ensure it remains coherent, comprehensible, and accessible. This is part of the work now being undertaken in the ALRC’s Financial Services Legislation Inquiry. However, there is also room for other ongoing review mechanisms.
  • Second, the need to ensure that the legislative framework for regulation provides an architecture that is sufficiently flexible to accommodate future changes. In the ALRC’s view, the structure of the Corporations Act – and particularly, the use of legislative instruments to modify or amend it – is unsuitable.

The recommendation of a more suitable legislative architecture will be a core component of the ALRC’s Interim Report B, due in September 2022, as part of its Financial Services Legislation Inquiry.

In the end, the history of Australian financial regulation highlights a risk of an entirely different stripe – the risk that the law will become, or already is, too complex, incoherent, or inaccessible to be understood or applied. However, that risk is also an opportunity: to improve the law for the benefit of all.

The ALRC hopes that readers will find the new background paper to be of interest, and that it will stimulate further engagement from stakeholders. Access the full background paper.

Dr William Isdale and Nicholas Simoes da Silva are both Senior Legal Officers at the Australian Law Reform Commission.

Footnotes
1 Stan Wallis, Financial System Inquiry (Final Report, 1997) 264.
2 Explanatory Statement, Corporations Amendment Regulations 2005 (No.5) (Cth) 24.
3 David Murray et al, Financial System Inquiry (Final Report, 2014) 28.
4 Sir Anthony Mason, ‘Corporate Law: The Challenge of Complexity’ (1992) 2 Australian Journal of Corporate Law 1.

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