Walking the regulatory tightrope
[ The University of Melbourne Voice Vol. 5, No. 6
14 September - 11 October 2009 ]
No country has escaped the effects of the Global Financial Crisis, but Australia’s regulatory system has lessened pain here compared with that experienced in the US and the UK. David Scott asks whether now that the smoke is clearing, is it time to reform the system all over again?
Australia’s economic performance during the current Global Financial Crisis (GFC) may not be written down with the same breathless fervour as the famous ‘twelve labours of Hercules’, but it remains a noteworthy achievement nonetheless, according to Professor Ian Ramsay. “When we look at the history of the Global Financial Crisis overseas, it’s a history of major financial institutions collapsing, with these collapses having a contagion or domino effect, with the result being an extraordinary lack of confidence in local and indeed global markets. But we haven’t really had that in Australia.
“Certainly the data shows that Australia, as of today, has done much better economically than most other countries, and certainly better than we would have thought a year to 18 months ago.”
The strong performance of the dollar appears to reflect increasing investor optimism following better than expected profit results from most areas; the Australian share market had its strongest finish in almost a year on August 14 (dating back to October 8, 2008). Just two days earlier, the Westpac-Melbourne Institute Consumer Sentiment Index, recorded a 3.7% increase from July, making it a 27.8% growth since May, a streak Westpac Senior Economist Matthew Hassan said is the biggest three months growth since the survey started in 1975. There was further good news in the Melbourne Institute’s Monthly Bulletin of Economic Trends, with GDP growth in 2009 revised up 0.1% to 0.5% towards the end of August.
A bounce in consumer confidence has certainly lifted the Australian economy while others around it continue to flounder. It would appear that Australia’s so-called “twin pillars” model of prudential regulation (through the Reserve Bank and APRA (Australian Prudential Regulation Authority) and consumer protection through ASIC (Australian Securities and Investments Commission), for a long time an unpopular choice of regulatory framework overseas, has held Australia in good stead. This is in contrast with the US system, where banks can be overseen by dozens of regulators, creating problems in co-ordinating effective supervision.
Professor Ramsay, one of the country’s leading corporate law experts and the Director of the Centre for Corporate Law and Securities Regulation at the Melbourne Law School, agrees. He says that Australia’s current strong performance, while linked to its strong regulatory framework, can be traced back further to the economic problems faced in the 1980s and the end of state banks. “What we saw was quite extraordinary; at least one of our major banks, Westpac, was teetering on the edge and in dire straits. At the same time a number of our other major banks had investment bank subsidiaries that lacked any effective oversight and minimal risk management.
“Though it’s some time ago, it’s an extraordinary history for a small economy, to lose some of your broad foundations in terms of financial institutions, and I think it was a wake-up call in terms of regulation, and we had a similar wake-up call after the collapse of HIH in 2001.” Australia’s pain of the past, a series of major collapses and near-collapses, has sharpened our regulatory focus and supervision for the future, providing improved consumer protection that isn’t as forthcoming overseas. It seems that only in times of crisis is there enough momentum to push through dramatic regulatory change.”
This seems particularly true in the case of the US, where the GFC has forced a rethink of the country’s entire financial regulatory framework, with less than impressive results. Indeed, there are many commentators and stakeholders who have expressed disappointment that a number of opportunities to complete massive retooling of regulatory structures in the US – the Obama administration’s proposed merger of the most powerful regulators in the capital markets, the Securities Exchange Commission and the Commodities and Futures Trading Commission – have been knocked back and left behind.
“The idea behind the merger was a sound one, providing one capital markets regulator and in the process reducing inter-agency turf wars, gaps in oversight and other issues,” says Associate Professor Cally Jordan, a former Wall Street lawyer who is an expert on international capital markets and now Deputy-Director of the Centre for Corporate Law and Securities Regulation at the Melbourne Law School. “There are reforms and changes coming through, but they are working at the margins rather than rethinking some of the profound structural difficulties and regulatory anomalies exposed by the financial crisis. In the US, it does seem to be only in the face of crisis that there is enough momentum to put through major reforms, when the bipartisan nature of the legislative process is set aside to deal with the crisis. And even in this instance, it’s struggled.”
Melbourne Law School Associate Professor Christine Parker notes that despite – or perhaps because of – all this, the US has a much longer history of stronger, criminal prosecution of those found breaching corporate regulations. “For example, the ‘perp walk’ has become famous as part of the US enforcement scheme for corporate regulation, and this is certainly not the case in Australia. In the US things are quite adversarial between business and regulators. Whereas in Australia the whole licensing system for every financial services institution has been managed in a relatively co-operative way. Certainly financial institutions have plenty of grumbles about ASIC and APRA and the unreasonableness or uncertainty of some of their demands. But broadly speaking, ASIC and APRA have managed to get financial institutions to internalise the need to comply with the rules and to take on the responsibility for policing themselves.
“But this doesn’t mean things are perfect.”
However local shareholders and executives shouldn’t brace themselves for wide sweeping changes, at least not yet. In the Australian setting, running maintenance appears to be the order of the day, a tolerable outcome for most given that in the face of some fairly large losses in the Australian economy there are still concerns about accountability, and pressure from interest groups demanding regulatory change. “It’s an understandable view, but one that’s not necessarily correct,” assesses Professor Ramsay.
A recent report by the Australian Government’s ‘Corporations and Markets Advisory Committee’ (CAMAC) is one example of the changes being proposed. The report recommends amendments in legislation regarding directors dealing with shares in their own companies and the introduction of stricter penalties for market misconduct (rumour-mongering), as well as improvements to corporate briefings of analysts. CAMAC Convener, Richard St John, says the proposals were about reinforcing good corporate practice and disclosure by directors and executive officers, promoting responsibility in market participation.
The GFC has also helped turn the spotlight on common issues that have been around before, but with an impact that has been heightened by the current financial climate. The debate over executive remuneration is one that has been brought into sharper focus due to the GFC, with many questioning whether senior executives are being provided with inappropriate financial incentives to engage in what amounts to short-term risk-taking. “It’s become a lightning rod for community concern, particularly during a time of rising unemployment,” says Professor Ramsay. “It’s one of those issues where you hope and look for private industry to take the lead and address the issue.”
At the end of August the Federal Government flagged more reforms to Australia’s regulatory model, stripping the Australian Securities Exchange of its authority to supervise trading on the stock exchange, passing the power onto ASIC. It’s a surprising and significant shift, according to Professor Ramsay. “It certainly significantly enhances the power ASIC has, but with new powers comes new responsibility, and it remains to be seen if ASIC has the expertise and resources to make it work.
“The Government obviously thinks it is appropriate to give powers to an independent regulator, particularly given the perceived conflict of interest the ASX has had for many years – on one hand, they are trying to run a profitable business yet on the other trying to deal with supervision and enforcement.”
Professor Ramsay, a member of CAMAC, is one who favours a longer term, a more considered view of reform. “All of us are shareholders and we’ve never had more of an interest in market integrity. Australia has one of the highest rates of share ownership in the world – latest ASX figures put Australia second only to the US – and that’s excluding ‘compulsory super’. Everyone now has a strong interest in ensuring the market has strong integrity.” Professor Ramsay highlights recent research he did on bankruptcy figures – showing more Australians than ever are becoming insolvent, and the ongoing GFC has only sped that rate up – which has led to a rapid legislative response from the government that perhaps hasn’t taken the time to evaluate how it matches up overseas. “Very recently the government has indicated that it’s looking at profound changes to bankruptcy law, such as reducing the period of bankruptcy. However the proposed changes are not up for discussion with anyone who has an interest in this area, financial brokers, lenders and so on. If you’re going to make dramatic changes to your bankruptcy laws, you need a proper consultation period.
“Sometimes pressures to undertake change can come from both outside the government and in, but regardless of where they come from, you need to adopt a principled approach to regulatory reform through research and through consultation. There can be quite a downside sometimes to the pressures to implement quick regulatory changes.”
The idea of increased competition among Australia’s ‘big four’ banks is one idea beyond corporate regulation that Professor Ramsay can see being considered as a response to the GFC. “There’s a very interesting tension here between financial stability and competition. You want a vibrant, competitive financial sector, but not at the expense of stability, where Australia has done very well. But the way the big banks are dominating bank deposits and the lending sector, they’ve squeezed out the medium players. Now, with the government guarantee on deposits, people are attracted to the big four more than ever, at the expense of competition from those outside. It’s a two-edged sword.”
For better or worse, a large part of any regulatory reform could be dictated by the US response, given Australia’s ongoing love of ‘copycat regulation’, according to Associate Professor Jordan. “In the financial sector, everyone is reading the same stuff and the same kind of information, so where there is a major issue in the US, it comes up as an issue here. Having said that, a lot of attention is paid to international standards and best practices, and Australia is very much in that international discourse, as it should be. But it is sometimes not as discriminating as it should be in implementing those standards, and in particular how it adapts US legislation on capital markets.”
The future danger is maintaining the grand balancing act; on one hand providing amendments to our regulatory forms so as to ensure they remain strong down the track and on the other, not destroying too much of the original frameworks that have held us in good stead. While the Federal Government has invested heavily in the economy with the admirable purpose of instilling greater confidence, and recent figures seem to show some success here, the amount of debt being accrued remains substantial, and certainly plays into what Kevin Rudd and Wayne Swan are referring to as a long and slow recovery. “The inevitable consequence of action now is that it will limit government involvement in the future, they will be constrained in what they can do while they service this high debt load,” says Professor Ramsay. “Even if we are now saying we’re heading out of the worst of the GFC, the costs will last a number of years, particularly in terms of limiting government options for the future.”
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