Assistant Treasurer Bill Shorten has moved to further consult the industry on whether compensation arrangements for consumers need to be strengthened as part of the Future of Financial Advice (FOFA) reforms.
The federal government yesterday released a report by financial services and corporate governance expert Richard St John which reviewed compensation arrangements for consumers of financial services and examined potential solutions.
St John said the current default arrangements which relied largely on professional indemnity insurance, provided a measure of assurance “but no guarantee that retail clients will be able to recover compensation” to which they may be entitled.
“The problem for consumers is where a provider does not have recourse to professional indemnity insurance cover and does not have the financial capacity to pay compensation. This may be the case where the provider has ceased to trade or has become insolvent,” he said.
St John said that under present arrangements there is very limited scrutiny of the financial resources of licensees.
“The general obligation of licensees to have available adequate resources to carry on their business is limited in its purpose,” he said.
“ASIC does not see the focus of its guidance on financial adequacy as the protection of clients against credit risk. It appears to regard the separate requirement on licensees to hold professional indemnity insurance as covering this issue,” St John said. He said this raised the question whether there should be some higher level of comfort that a licensee has adequate resources, when considered in relation to the extent of its insurance cover, to meet compensation claims from clients.
He said for example, licensees might be required to hold an additional form of financial security as a general condition of licence, such as a capital holding or a security bond or guarantee from a financial institution or related entity.
“The aim would be to give the licensee more capacity to meet awards of compensation that are not covered by professional indemnity insurance,” St John said.
“The question is whether some form of financial security, short of that kind of regulation, would in a practical way reduce the risk of a licensee being unable to meet a claim for compensation. Any such benefit would have to be weighed against the effects of a stricter requirement on barriers to entry and competition in financial services,” he said.
Arrangements of this type applied to investment firms in the United Kingdom who are required to meet capital adequacy requirements in conjunction with their holding of professional indemnity insurance cover. Industry participants had until 1 June to provide submissions to the government. The recommendations will be made after that date.
In the past, St John has held the role of mining group BHP Billiton’s general counsel and also the HIH Royal Commission’s chief executive.
