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‘Twin Peaks’ regulatory architecture

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1 ‘Twin Peaks’ regulatory architecture
1997: THE WALLIS INQUIRY The origins of ‘Twin Peaks’ in Australia ‘Twin Peaks’ regulatory architecture APRA ASIC

2 DAVID MURRAY, THEN AND NOW
How times have changed [$160 billion] Savings and loan (S&L) associations, or ‘thrifts’, are the equivalent of building societies in the UK and Australia.

3 FINANCIAL SYSTEM INQUIRY: INTERIM REPORT
Twin Peaks has proven “robust and effective”

4 WHO WATCHES THE WATCHERS?
A FINANCIAL REGULATORY ARCHITECTURE FOR THE POST-LEHMAN WORLD Martin Foo | The Treasury FSC Deloitte Future Leaders Award Program 13 October 2014

5 PRESENTATION OVERVIEW
HISTORY: How did we arrive at Twin Peaks? GLOBAL COMPARISON: What are the alternatives to Twin Peaks? CASE STUDIES: AIG, FSA, US Treasury Blueprint REFINEMENTS: Optimal structure for the future CONCLUSIONS: Six propositions

6 IT’S SHORTER THIS TIME, I PROMISE!
Argumentum verbosium

7 THE HISTORY OF FINANCIAL REGULATION
Financial institutions operate under State legislation Banking Act 1945: First attempt at (partial) prudential regulation Insurance and Superannuation Commission (ISC) Australian Financial Institutions Commission (AFIC) APRA 1900 1920 1940 1960 1980 2000 Federation PRUDENTIAL REGULATION BUSINESS CONDUCT AND MARKETS REGULATION ASIC Australian Securities Commission (ASC) Huddart, Parker & Co Pty Ltd v Moorehead Uniform Companies Acts of the six States Australian Stock Exchange (ASX) Interstate Corporate Affairs Commission (ICAC) National Companies and Securities Commission (NCSC)

8 REGULATORY FRAGMENTATION
Supervisory boundaries are determined by the distribution of Constitutional powers 51. Legislative powers of the Parliament The Parliament shall, subject to this Constitution, have power to make laws for the peace, order, and good government of the Commonwealth with respect to: (xiii) banking, other than State banking; also State banking extending beyond the limits of the State concerned, the incorporation of banks, and the issue of paper money; (xiv) insurance, other than State insurance; also State insurance extending beyond the limits of the State concerned;

9 WHAT IS A BANK? Is there a functional difference between banks, building societies and credit unions?* “… to give an inclusive and exclusive definition of such a conception as banking is almost impossible” – JUSTICE OWEN DIXON (1947) * Most judgments took the view that ‘banking’ was defined primarily by the acceptance of deposits. Perhaps the only genuine difference between banks and building societies / credit unions, in terms of activities they undertook, was that the latter had been excluded from direct participation in the payments system. But from 1997, building societies and credit unions were able to issue cheques in their own right.

10 CASE STUDY 1: PRUDENTIAL SUPERVISION IN THE U.S.
The US Treasury’s “Blueprint for a Modernized Financial Regulatory Structure”

11 PROPOSITION 1 Financial institutions that undertake similar activities should be regulated in similar ways. Why? Administrative efficiency Competitive neutrality Economic function matters more than legal identity Flexibility to respond to non-traditional entrants (e.g. supermarkets, tech companies)

12 GLOBAL COMPARISON: PRUDENTIAL SUPERVISION
Prudential supervision of banks, insurers and securities firms (including private pension funds) pre-GFC* Single prudential supervisor (33%) *For a dataset of 85 countries analysed by the IMF, based on data in Central Banking Publications (2004).

13 GLOBAL COMPARISON: PRUDENTIAL SUPERVISION
Prudential supervision of banks, insurers and securities firms (including private pension funds) pre-GFC* One agency supervises two sectors (26%) Three or more prudential supervisors (41%) *For a dataset of 85 countries analysed by the IMF, based on data in Central Banking Publications (2004).

14 CROSS-SECTOR CONSOLIDATION
The emergence of financial conglomerates (e.g. the Big Four banks) and the ‘blurring of boundaries’ Superannuation funds management Big four banks’ share of industry FUM 2004 - 05 24% 2012 - 13 26% Life insurance Big four banks’ share of industry premium and investment revenue 2009 - 10 11% 2012 - 13 27% Financial planning and advice Big four banks’ share of industry revenue 2007 - 08 15% 2012 - 13 36% Source: Macroeconomics, 2014, Review of the Major Banks’ Control of the Wider Financial Sector

15 INTEGRATED PRUDENTIAL SUPERVISION
Is one watchdog better than three? NUMBER OF FULLY-INTEGRATED SUPERVISORY AUTHORITIES WORLDWIDE Netherlands Japan Australia South Africa Korea, United Kingdom Norway Denmark Year of Establishment

16 CASE STUDY 2: AIG AND REGULATORY ARBITRAGE
The Financial Crisis Inquiry Commission’s findings on the Office of Thrift Supervision (OTS)

17 Prevalence of conglomerates that operate in multiple sectors
PROPOSITION 2 A single agency should regulate deposit-taking institutions, insurers and private pensions.* Why? Economies of scale Clear accountability Prevalence of conglomerates that operate in multiple sectors Consistent with international trends (e.g. EU Financial Conglomerates Directive)** * In Australia, health insurers are not (yet) regulated by APRA. Self-managed superannuation funds are regulated by the ATO. ** Foreign companies doing business in Europe are required to have the equivalent of a “consolidated supervisor” in their home country.

18 GLOBAL COMPARISON: BUSINESS CONDUCT REGULATION
Five different approaches, for selected high-income countries WHICH AGENCY IS RESPONSIBLE FOR CONDUCT REGULATION? Twin Peaks Central bank Universal regulator (integrated prudential and business conduct regulator) Sectoral prudential supervisors (‘lead regulator’ for each sector) N/A* – Ombudsman, complaints board, financial consumer agency** Australia Belgium Netherlands New Zealand United Kingdom Czech Republic Ireland Germany Hungary Iceland Japan Korea Poland Switzerland Italy Israel Luxembourg Portugal Spain UAE Austria Canada Denmark Greece Singapore Slovak Republic Sweden * No agency with statutory responsibility for business conduct regulation of the banking sector. ** In the United States, the Consumer Financial Protection Bureau was officially opened in July 2011. Source: Melecky, M. and Podpiera, A.M., 2012, Institutional Structures of Financial Sector Supervision, Their Drivers and Emerging Benchmark Models; author’s own research

19 PROPOSITION 3 A single agency should be responsible for business conduct regulation, but not necessarily financial consumer protection too. Why? Administrative efficiency Prevalence of conglomerates that operate in multiple sectors But: synergies associated with placing conduct regulation and financial consumer protection in the same agency may be overstated

20 THE UNIVERSAL REGULATOR MODEL
E pluribus unum? Universal Regulator (Integrated Prudential and Conduct Regulation) Separate Prudential and Conduct Regulation No. of Countries 25 101 Examples (G20) Germany Japan Korea United Kingdom (1998–2012) Argentina Australia* Brazil Canada China France India Indonesia Italy Mexico Russia South Africa Turkey United States * Interestingly, the former Minister for Superannuation and Corporate Law, Senator Nick Sherry, floated the idea of merging APRA and ASIC before the 2007 election.

21 DIFFERENT REGULATORY CULTURES
Two heads are better than one ASIC Focus on enforcement Establishment of a credible deterrent APRA Focus on rehabilitation Maintenance of financial health

22 CASE STUDY 3: FINANCIAL SERVICES AUTHORITY (FSA)
Prudential regulation plays second fiddle

23 PROPOSITION 4 Prudential supervision and conduct regulation responsibilities should continue to be housed in different agencies. Why? Clarity of purpose Respond to differing forms of market failure Prevents the subordination of one form of regulation to the other

24 REGULATORY COORDINATION
Key relationships between CFR agencies and other entities* ASX | Chi-X Financial Reporting Council Standard Business Reporting MOU Director of Public Prosecutions MOU MOU MOU Treasury ASIC Board Membership MOU PHIAC MOU MOU MOU CFR MOU Financial Distress Management MOU Ex-Officio Appointment MOU Breach Notification Agreement MOU ACCC MOU Transfer of Functions MOU ATO MOU MOU RBA APRA MOU Coordination Committee MOU MOU MOU Coordination Committee AUSTRAC MOU Payments System Board MOU Australian Bureau of Statistics * Representative sample only. APRA and ASIC have MOUs with approximately 14 domestic bodies apiece.

25 PROBLEM 1: REGULATORY OVERLAP (AND UNDERLAP)
How should APRA and ASIC coordinate? ASIC thought it could rely on APRA, says Knott The Age, 15 November 2002 Prudential role for ASIC may be considered by parliamentary inquiry Money Management, 30 April 2009 ASIC plans call for ‘super-regulator’ The Sydney Morning Herald, 16 September 2009 APRA and ASIC have case to answer on Trio Capital Super Review, 17 May 2012 Big banks want Murray inquiry to cut regulatory uncertainty The Australian Financial Review, 15 April 2014

26 PROBLEM 2: MOUs DON’T ALWAYS WORK
Trans-Tasman relations: The introduction of a deposit guarantee in Australia

27 PROBLEM 2: MOUs DON’T ALWAYS WORK
Trans-Tasman relations: The introduction of a deposit guarantee in Australia

28 PROBLEM 3: ARE WE OVER-REGULATED?
The costs of implementing Basel III $228m

29 PROPOSITION 5 The Council of Financial Regulators should be given statutory recognition and serve as a forum for resolving regulatory overlap – and the ACCC should be made a permanent member. Why? Enhanced inter-agency coordination Democratic accountability (rather than clubby cooperation) Greater focus on systemic stability Reduction in the dominance of the RBA Higher priority on competition

30 FINAL REMARKS: PROPOSITION 6
Sound regulatory architecture is a necessary but not sufficient condition for a well-functioning system. Why? Regulation involves considerable unpredictability Many other factors, including regulatory culture, funding and management – as well as broader elements like macroeconomic fundamentals and corporate governance – matter

31 THANK YOU FOR LISTENING
Who Watches the Watchers? A Financial Regulatory Architecture for the Post-Lehman World FSC Deloitte Future Leaders Award Program Final Presentation – 13 October 2014 Martin Foo Phone: (02)

32 ACKNOWLEDGEMENTS The author would like to thank FSC and Deloitte staff for organising the FSC Deloitte Future Leaders Award Program, as well as judges and fellow participants, in what has been a motivating and rewarding journey. Thanks are also due to Kate for her unwavering encouragement and support. The views expressed in this presentation are the author’s own and should not be attributed to the Treasury or the Australian Government. PowerPoint slides based on templates by DesignDistrict

33 REFERENCES Abrams, R.K. and Taylor, M.W., 2000, Issues in the Unification of Financial Sector Supervision, IMF Working Paper. Access Economics, 2009, Navigating Reform: Australia and the Global Financial Crisis, Published by FINSIA. APRA and ASIC, 2010, Memorandum of Understanding Between the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission. Aylmer, S., 1997, Commonwealth Bank Doubt Over Wallis Plan, The Age, 24 April. Republished in CEDA Bulletin, July 1997, p. 11. Bakir, C., 2009, The Governance of Financial Regulatory Reform: The Australian Experience, Journal of Public Administration, Vol. 87, No. 4, pp. 910 – 922. Barth, J.R., Caprio, G. and Levine, R., 2013, Bank Regulation and Supervision in 180 Countries from 1999 to 2011, NBER Working Paper. Berg, C., 2008, The Growth of Australia’s Regulatory State, Institute of Public Affairs. Bird, J., 2012, Regulating the Regulators: Accountability of Australian Regulators, Sydney Law School, Legal Studies Research Paper. Black, J. and Jacobzone, S., 2009, Tools for Regulatory Quality and Financial Sector Regulation: A Cross-Country Perspective, OECD Working Papers on Public Governance, No. 16, OECD Publishing. Blees, W., 2010, Prudence Pays, Risk Australia, Spring Issue. Blinder, A.S., 2013, After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead, Penguin Books. Bora, B. and Lewis, M.K., 1997, The Australian Financial System: Evolution, Regulation, and Globalization, Law and Policy in International Business, 28, 3, pp. 787 – 811. Boyd, T., 2014, APRA Warns Hockey, Australian Financial Review, 30 June, p. 1. Brown, E.F., 2010, A Comparison of the Handling of the Financial Crisis in the United States, the United Kingdom and Australia, Villanova Law Review, Volume 55, No. 3, pp. 509 – 576. Carling, R.G., 2012, Regulation or Strangulation? Banking After the Global Financial Crisis, The Centre for Independent Studies, CIS Policy Forum 23.

34 REFERENCES (CONT.) Carmichael, J., 2002, APRA – The Way Forward, Address to CEDA Conference, 22 November. Carmichael, J., 2014, Implementing Twin Peaks: Lessons from Australia, Institutional Structure of Financial Regulation: Theories and International Experiences, Chapter 5, Taylor & Francis. Carmichael, J., Fleming, A. and Llewellyn, D.T. (eds), 2004, Aligning Financial Supervisory Structures with Country Needs, World Bank Institute. Chaaya, M., 2011, The Regulation of Trustee Governance in Australia: Time for a Rethink?, IPEBLA 13th International Conference, 23 May. Chapman, G. (Senator), 2001, Speech to the Senate, 21 June, 4.05pm. Available via Commonwealth Hansard. Cihak, M. and Podpiera, R., 2006, Is One Watchdog Better than Three? International Experience with Integrated Financial Sector Supervision, IMF Working Paper. Cooper, J., 2006, The Integration of Financial Regulatory Authorities – The Australian Experience, Paper presented to the Comissão de Valores Mobiliários (Securities and Exchange Commission of Brazil) 30th Anniversary Conference, Rio de Janeiro. Economics References Committee, 2014, Performance of the Australian Securities and Investments Commission, The Senate. Eisenbeis, R.A., 2009, What We Have Learned and Not Learned from the Current about Financial Reform, The Australian Economic Review, Vol. 42, No. 4, pp. 457 – 469. Enriques, L. and Hertig, G., 2010, The Governance of Financial Supervisors: Improving Responsiveness to Market Developments, European Corporate Governance Institute, Law Working Paper No. 171/2010. Erskine, E., 2014, Regulating the Australian Financial System, Australian Centre for Financial Studies, The Funding Australia’s Future Project. Ferguson, A., Butler, B. and Williams, R., 2013, Scrutinising ASIC: Is it a Watchdog or Dog with No Bite?, The Age, 23 November. Ferran, E., 2014, Institutional Design for Financial Market Supervision: The Choice for National Systems, University of Cambridge Legal Studies Research Paper Series, Paper No. 28/2014.

35 REFERENCES (CONT.) Flamee, M. and Windels, P., 2009, Restructuring Financial Sector Supervision: Creating a Level Playing Field, The Geneva Papers, 34, pp. 9 – 23. Gadinis, S., 2013, From Independence to Politics in Financial Regulation, California Law Review, Vol. 101, pp. 327 – 406. Group of Thirty, 2008, The Structure of Financial Supervision: Approaches and Challenges in a Global Marketplace. Haldane, A.G., 2012, The Dog and the Frisbee, Speech given at the Federal Reserve Bank of Kansas City’s 366th Economic Policy Symposium, “The changing policy landscape”, Jackson Hole, Wyoming, 31 August. Hill, J., 2012, Why Did Australia Fare So Well in The Global Financial Crisis?, Sydney Law School, Legal Studies Research Paper. HM Treasury, 2011, A New Approach to Financial Regulation: Building a Stronger System. International Monetary Fund (IMF), 2012, Australia: Financial System Stability Assessment, IMF Country Report No. 12/308. Jones, R.M., 2010, Back to Basics: Why Financial Regulatory Overhaul is Overrated, Entrepreneurial Business Law Journal, 4, No. 2, pp. 391 – 406. Lui, A., 2012, Single or Twin? The UK Financial Regulatory Landscape after the Financial Crisis of 2007–2009, Journal of Banking Regulation, 13, pp. 24 – 35. Macroeconomics, 2014, Review of the Major Banks Control of the Wider Financial Sector, Report Commissioned by Customer Owned Banking Association. Maddock, R., 2014, Red Tape in Finance and its Discontents, Economic and Political Overview 2014, CEDA, pp. 48 – 55. Maddock, R., Dimasi, J. and King, S.P., 2014, Rationalising Rustic Regulators, Monash Business Policy Forum. Masciandaro, D., Nieto, M. and Quintyn, M., 2009, Financial Supervision in the EU: Is There Convergence in the National Architectures?, Journal of Financial Regulation and Compliance, 17, No. 2, pp. 86 – 95. Mees, B. and Ramsay, I.M., 2008, Corporate Regulators in Australia ( ): From Companies’ Registrars to the Australian Securities and Investments Commission, Melbourne Law School, Centre for Corporate Law and Securities Regulation.

36 REFERENCES (CONT.) Melecky, M. and Podpiera, A.M., 2012, Institutional Structures of Financial Sector Supervision, Their Drivers and Emerging Benchmark Models, Munich Personal RePEc Archive. Mwenda, K.K., 2006, Legal Aspects of Financial Services Regulation and the Concept of a Unified Regulator, The World Bank. Owen, N. (Justice), 2003, The Failure of HIH Insurance, HIH Royal Commission, Vol. 1. Pan, E.J., 2010, Four Challenges to Financial Regulatory Reform, Villanova Law Review, Vol. 55, 3, pp. 743 – 772. Pan, E.J., 2011, Structural Reform of Financial Regulation, Transnational Law and Contemporary Problems, Vol. 19, pp. 796 – 867. Pellerin, S.R., Walter, J.R. and Wescott, P.E., 2009, The Consolidation of Financial Regulation: Pros, Cons, and Implications for the United States, Economic Quarterly, Vol. 95, No. 2, pp. 121 – 160 Productivity Commission, 2011, Identifying and Evaluating Regulation Reforms, Productivity Commission Research Report. Quintyn, M., Ramirez, S. and Taylor, M.W., 2007, The Fear of Freedom: Politicians and the Independence and Accountability of Financial Sector Supervisors, IMF Working Paper. Surowiecki, J., 2008, Parsing Paulson, The New Yorker, April 28. Surowiecki, J., 2010, The Regulation Crisis, The New Yorker, June 14. The Department of the Treasury (US), 2008, Blueprint for a Modernized Financial Regulatory Structure, United States of America. The Financial Crisis Inquiry Commission, 2011, The Financial Crisis Inquiry Report, United States of America. The Treasury, 2012, Strengthening APRA’s Crisis Management Powers, Consultation Paper. Thomson, D. and Abbott, M., 2000, Australian Financial Prudential Supervision: An Historical View, Australian Journal of Public Administration, 59(2), pp. 75 – 88. Turner, A., 2009, The Turner Review: A Regulatory Response to the Global Banking Crisis, Financial Services Authority. Weber, R.H., Arner, D.W., Gibson, E.C. and Baumann, S., 2014, Addressing Systemic Risk: Financial Regulatory Design, Texas International Law Journal, Vol. 49, pp. 149 – 200. World Bank, 2013, Global Financial Development Report, The State as Regulator and Supervisor, Chapter 2.


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