Why advice compensation costs could skyrocket under CSLR

Alex Burke,  Senior Writer,  No More Practice Education

Not long ago, we discussed the potential costs involved in the Government's proposed compensation scheme of last resort (CSLR), which would be funded via an industry levy mirroring the model used by ASIC. 

Needless to say, the news of an additional levy for advisers (on top of the as-yet-unchanged ASIC one) attracted considerable attention from the sector, with multiple associations signing a joint response that characterised the draft CSLR legislation as the "last straw for the financial advice industry." It wasn't just the cost itself, the letter argued, but the idea that the CSLR levy disproportionately burdened advisers while completely excluding other industry participants such as product manufacturers. 

Meanwhile, the proposed CSLR also attracted criticism in the political arena. Labor MP Stephen Jones, for example, described it as being "four years late" and said the $150,000 compensation cap was substantially below the $550,000 amount recommended by the Royal Commission. 

Now the FSC has joined the fray. Using research commissioned from EY, the FSC has challenged the Government's $8 million forecasted costs of advice failures, saying that the figure could rise to nearly $60 million when events such as financial crises are taken into account. Without the current compensation cap, EY estimates the scheme could cost as much as $105.7 million per annum. 

While the amount an advice firm would be required to pay in the event of such a cost blowout is restricted by the scheme's $10 million subsector cap and $250 million overall cap, it's worth noting that establishment costs aren't included in these limits. On top of that, the overseeing Minister will have the ability to impose special levies when the CSLR operator notifies them that subsector outlays are expected to exceed their respective funding caps. 

What, then, does the FSC suggest as a means of preventing CSLR "bill shock"? First, the association recommends removing the $1,000 minimum levy threshold for advisers under a "one in, all in" principle. If this isn't done, then the levy minimum should be reduced to $500 and, when additional funding is required, it should be raised from advice businesses that have not yet contributed to the scheme. 

Furthermore, the FSC has requested greater transparency regarding the CSLR levy methodology. Currently, the legislation uses terminology such as costs being "reasonably attributable" based on what the CSLR operator "reasonably believes," which the FSC's submission argues "leaves room for discretion" and should be remedied via a more prescriptive regulatory approach. 

The submission also advocates stricter capital and PI requirements for advice licensees, both of which would be mandated and monitored by ASIC, and that the CSLR operator should have an obligation to "stand in the shoes of the policyholder" and recover all or partial compensation costs from insurance. This, the submission notes, is a similar model to the one used by the UK's Financial Services Compensation Scheme and would substantially cut down the costs of the CSLR. 

Finally, the FSC has also recommended a change in the proposed CSLR ownership structure. Rather than being run as a subsidiary of AFCA - which could, the submission argues, "[administer] unpaid determinations and [recover] unpaid determination costs from a subsidiary with common directors" - the CSLR should be operated by Treasury. The submission adds that this would also "[remove] the unnecessary costs associated with having a board for the CSLR operator for essentially an administrative function." 

Commenting on these proposals, FSC CEO Sally Loane said: "For the CSLR to genuinely be a scheme of last resort for consumers ASIC must strengthen its oversight of existing requirements for advice licensees to have appropriate capital, professional indemnity insurance and compensation arrangements in place."

Loane continued: "Weak enforcement has been a significant contributor to the current scale of unpaid determinations and the future cost of the scheme, and a more proactive approach to enforcing the law is essential.

"Why put a safety net under a leaky bucket? Mandating that sound financial services businesses to fund consumer compensation for those businesses which have failed is a moral hazard writ large." 

Of course, it's worth noting that while the FSC envisages "a degree of cross-subsidisation" in the CSLR funding scheme, this should largely be contained within the products and services included in the CSLR. In the instance where a Ministerial determination is made regarding additional CSLR funding from industry sectors not included in the CSLR's scope (such as some of those represented by the FSC), this should be proportionately spread across all financial services providers required to hold AFCA membership. 

The FSC's submission describes this as an approach "underpinned by principles of equity," but it does once again raise the question of why other AFCA members were excluded from the CSLR in the first place. As the AFA said in its own submission, "we are astonished that managed investment schemes have been excluded from the proposed scope of the scheme" despite being the second-largest contributor to unpaid determinations (according to a 2018 FOS submission to the Royal Commission). 

Like the FSC, the AFA also compared the CSLR to the UK's Financial Services Compensation Scheme, noting that the latter includes deposit and investment products along with life insurance and pensions.

"The UK scheme is much broader than what has been proposed in Australia," the AFA added. "The Government has provided no justification for why that is the case." 

It would appear that, regardless of what measures are taken to reduce the overall cost of the CSLR, advisers will foot the majority of the bill. 

 


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