The final report of the Murray Financial System Inquiry (the Inquiry) was released on 7 December 2014. The Inquiry made 44 recommendations relating to the Australian financial system. The Inquiry identified two general themes where there is significant scope to improve the functioning of the financial system:
- funding the Australian economy; and
The Inquiry identified a number of distortions that impede the efficient market allocation of financial resources, including taxation, information imbalances and unnecessary regulation. Reducing the distortionary effects of taxation should lead the system to allocate savings (including foreign savings) more efficiently and price risk more accurately. The Inquiry has referred identified tax issues for consideration in the Tax White Paper.
SMSF borrowings – prohibition on LRBAs
The Inquiry recommended removing the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements (LRBAs) by superannuation funds. The report recommended that the current superannuation borrowing exception in s 67A of the SIS Act should be removed on a prospective basis. Importantly, superannuation funds with existing borrowings would be permitted to maintain those borrowings. However, funds disposing of assets purchased via direct borrowings would be required to extinguish any associated debt at the same time. Key points include the following:
- Since 24 September 2007, super funds have been allowed to borrow pursuant to a limited recourse borrowing arrangement (LRBA) that strictly complies with the requirements in s 67A and 67B of the SIS Act. The current provisions allow superannuation funds (especially SMSFs) to borrow directly, with the underlying asset quarantined in a holding trust arrangement.
- The Inquiry panel noted that the amount of money borrowed by superannuation funds using LRBAs has increased from $497 million in June 2009 to $8.7 billion in June 2014. While the limited recourse nature of these arrangements alleviates the risk of losses resulting in claims over other fund assets, the Inquiry argues that LRBAs still magnify the chances of large losses (either inside or outside the fund). According to the final report, further growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system. The report argues that the prohibition of LRBAs will help to “prevent the unnecessary build-up of risk in the superannuation system and the financial system more broadly”. In addition, the report claims that borrowing by superannuation funds transfers some of the downside risk to taxpayers, who underwrite the safety net provided through the age pension.
- When the interim report was released in July 2014, the SMSF Professionals’ Association of Australia (SPAA) argued that any changes to the use of borrowing by superannuation funds should target the “fringes” of the superannuation borrowing market and concentrate on inappropriate promotion of borrowing in superannuation funds. At the time, SPAA CEO Andrea Slattery said that the use of gearing by SMSFs was being done “sensibly” and only used by a very small percentage (0.5%) of SMSFs. According to Mrs Slattery, most loans made to SMSFs are being made with responsible lending practices. Banks have tighter lending policies and have experienced lower levels of default with this type of credit facility compared with loans made for other purposes, Mrs Slattery said.
Other recommendations made by the Inquiry
The Inquiry also made the following recommendations:
Income product
Require superannuation trustees to pre-select a comprehensive income product for members’ retirement. The product would commence on the member’s instruction, or the member may choose to take their benefits in another way. Impediments to product development should be removed.
Fund choice
Provide all employees with the ability to choose the fund into which their superannuation guarantee contributions are paid.
Competency of financial advice providers
Raise the competency of financial advice providers and introduce an enhanced register of advisers.
In the Inquiry’s view, the minimum standards for those advising on Tier 1 products should include the following:
- a relevant tertiary degree;
- competence in specialised areas, such as superannuation, where relevant; and
- ongoing professional development (including technical skills, relationship skills, compliance and ethical requirements) to complement the increased focus on standards of conduct and professionalism as recommended elsewhere in the report.
Although the Inquiry did not recommend a national exam for advisers, it said this could be considered if issues in adviser competency persist.
Register of advisers
The Inquiry supported the establishment of the enhanced register to facilitate consumer access to information about financial advisers’ experience and qualifications and improve transparency and competition. It suggested that further consideration could be given to adding other fields, such as determinations by the Financial Ombudsman Service (FOS). The register should be designed to take into account future developments in automated advice and record the entity responsible for providing such services.
Interests of financial firms and consumers
Better align the interests of financial firms with those of consumers by raising industry standards, enhancing the power to ban individuals from management and ensuring remuneration structures in life insurance and stockbroking do not affect the quality of financial advice.
Create new Financial Regulator Assessment Board
The report recommends creating a new Financial Regulator Assessment Board to advise the Government annually on how financial regulators have implemented their mandates.
“General advice” and ownership structures
The Inquiry recommended renaming “general advice” and requiring advisors and mortgage brokers to disclose ownership structures. The current regulatory framework addresses advice on financial products. The framework makes the following important distinction between personal and general advice:
- Personal advice takes account of a person’s needs, objectives or personal circumstances, whereas general advice does not.
- General advice includes guidance, advertising, and promotional and sales material highlighting the potential benefits of financial products. It comes with a disclaimer stating that it does not take a consumer’s personal circumstances into account.
However, the report says consumers may misinterpret or excessively rely on guidance, advertising, and promotional and sales material when it is described as “general advice”. The use of the word “advice” may cause consumers to believe the information is tailored to their needs. Behavioural economics literature and ASIC’s financial literacy and consumer research suggests that terminology affects consumer understanding and perceptions. Often consumers do not understand their financial adviser’s or mortgage broker’s association with product issuers.
The Inquiry believes greater transparency regarding the nature of advice and the ownership of advisers would help to build confidence and trust in the financial advice sector. In particular, the report said “general advice” should be replaced with a more appropriate, consumer-tested term to help reduce consumer misinterpretation and excessive reliance on this type of information. The Inquiry believes the benefits to consumers from clearer distinction and the reduced need for warnings outweigh any costs that would be involved.
Tax White Paper
The Inquiry identified a number of taxes that it said distorts the allocation of funding and risk in the economy. The Inquiry also identified other tax issues that may adversely affect outcomes in the financial system. Unless they are already under active Government consideration, the report said the tax issues it flagged should be considered as part of the Tax White Paper process. These include the following issues:
- In reviewing the taxation of contributions and investment earnings in superannuation, the Tax White Paper process should consider aligning the earnings tax rate across the accumulation and retirement phases.
- Tax concessions in the superannuation system are not well targeted to achieve provision of retirement incomes.
- The relatively unfavourable tax treatment of deposits and fixed-income securitiesmakes them less attractive as forms of savings and increases the cost of this type of funding.
- Negative gearing and CGT concessions:
- Capital gains tax concessions for assets held longer than a year provide incentives to invest in assets for which anticipated capital gains are a larger component of returns. The report said reducing these concessions would lead to a more efficient allocation of funding in the economy.
- For leveraged investments, the report said the asymmetric tax treatment of borrowing costs incurred in purchasing assets (and other expenses) and capital gains, can result in a tax subsidy by raising the after-tax return above the pre-tax return. Investors can deduct expenses against total income at the individual’s full marginal tax rate. However, for assets held longer than a year, nominal capital gains, when realised, are effectively taxed at half the marginal rate. All else being equal, the increase in the after-tax return is larger for individuals on higher marginal tax rates.
- The report said tax treatment of investor housing, in particular, tends to encourage leveraged and speculative investment. Since the Wallis Inquiry, higher housing debt has been accompanied by lenders having a greater exposure to mortgages. Housing is a potential source of systemic risk for the financial system and the economy.
- The case for retaining dividend imputationis less clear than in the past. To the extent that dividend imputation distorts the allocation of funding, a lower company tax rate would likely reduce such distortions. The report said the benefits of dividend imputation, particularly in lowering the cost of capital, may have declined as Australia’s economy has become more open and connected to global capital markets. If global capital markets set the (risk-adjusted) cost of funding, then dividend imputation acts as a subsidy to domestic equity holders. That would create a bias for domestic investors, including superannuation funds, to invest in domestic equities. The report said imputation provides little benefit to non-residents that invest in Australian corporates.
- For non-residents, repatriated income from Australian investments is, in some cases, subject to withholding tax. The unequal tax treatment of repatriated income may affect the funding decisions of Australian entities and place Australia at a competitive disadvantage internationally. Lower, more uniform withholding tax rates would unwind these distortions.
- Simplifying the tax rules for Venture Capital Limited Partnerships (VCLPs) and streamlining Government administration of the regime would reduce barriers to fundraising.
- GSTis not levied on most financial services. This may contribute to the financial system being larger than it otherwise would be.
Consultation and comments
The Treasurer said the Government intends to consult with industry and consumers before making any decisions on the recommendations. Written submissions are being sought from all stakeholders, including industry and members of the public. As a number of recommendations are the responsibility of the financial regulators – APRA, ASIC and the RBA – those submissions will be made available to these agencies unless the submitter indicates otherwise.
Comments close on 31 March 2015 and should be sent to: Senior Adviser, Financial System and Services Division, The Treasury, Langton Crescent, Parkes ACT 2600; email: fsi@treasury.gov.au. For enquiries, please call David Crawford on (02) 6263 2757.