Review of compensation arrangements for consumers of financial services
Future of financial advice

© Commonwealth of Australia 2011
ISBN  978‑0‑642‑74683‑2

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The then Minister for Financial Services, Superannuation and Corporate Law, the Hon Chris Bowen MP, engaged me to review and report to the Government on the need for, and costs and benefits of, a statutory compensation scheme for financial services.
The review is being undertaken in the context of the Government’s response to the report of the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into financial products and services in Australia. Recommendation 10 of the report was ‘... that the Government investigate the costs and benefits of different models of a statutory last resort compensation fund for investors’.
The review is an element of a broader package of changes for financial advice announced by the Government on 26 April 2010. 
This consultation paper is a step towards the preparation of my recommendations to Government. It reflects initial research in which I have been assisted by a review secretariat in the Department of the Treasury and the outcome of preliminary consultations I have had with industry participants, regulators and other interested parties. 
In releasing this paper, I draw attention to a number of issues on which comment is invited. These are raised at the end of Chapters 2 to 5. I am also seeking reactions to the preliminary observations I have made in Chapter 5. These observations are a pointer to issues I see as relevant to the review, but respondents should feel free to address other issues as well. 
I intend to continue the consultation process in the period following the release of this paper and leading up to my preparation of recommendations to the Government. 
I express my appreciation to the individuals and bodies who have already provided views or contributed information to the review including ASIC and FOS for their assistance.

Contents

Consultation process	ix
Outline of paper	x
Chapter 1: Introduction and background	1
Terms of reference	1
Relevant concepts and issues of scope	2
Financial services	3
Financial services industry	3
Retail clients	5
Obligations on licensees	6
Financial loss in absence of misconduct	7
Basis of financial services regulation	7
Licensing regime for financial service providers	9
Context of compensation arrangements	12
Future of Financial Advice reforms	14
Chapter 2: Current compensation arrangements	17
Arrangements under s912B of the Corporations Act	18
Exemptions from compensation arrangements	20
Alternative arrangements	20
Coverage of representatives	20
Disclosure of compensation arrangements	21
Insurance as a basis for compensation	21
Run‑off cover	23
Insurance provider	23
ASIC administration of insurance requirement	23
Grounds for compensation claims	24
Avenues for consumer redress	26
Alternative dispute resolution mechanisms	27
EDR scheme awards and professional indemnity insurance	32
Other financial sector compensation arrangements	34
Compensation regime for financial markets	34
Financial Claims Scheme for depositors and policyholders	37
Compensation arrangements for superannuation funds	38
Compensation arrangements for credit providers	39
Issues of interest	41

Chapter 3: Compensation arrangements in practice	45
Market for professional indemnity insurance	46
Supply of professional indemnity insurance	47
Demand for professional indemnity insurance	47
Access to insurance cover by licensees	47
Cost of professional indemnity insurance	49
Trends in insurance claims	50
Insurance as a means of compensation	52
Benefits of professional indemnity insurance	52
Limitations of professional indemnity insurance	52
Consequences where insurance not available	56
Inability of retail clients to recover compensation	57
Westpoint	58
Storm Financial	60
Other corporate collapses	60
Issues of interest	62
Chapter 4: Comparison with other arrangements	63
UK compensation arrangements	66
Operation of UK arrangements	69
New prudential requirements	69
Proposed changes to UK regulatory architecture	70
Schemes in other countries	71
Operation of schemes in Canada, USA and EU	72
Compensation schemes in other industry sectors	72
Professional indemnity insurance schemes	73
Issues of interest	74
Chapter 5: Observations and issues	75
Introduction	77
Consumer protection relatively well developed	78
Focus on fallback compensation arrangements	79
Mandate for fallback arrangements	79
Implementation of fallback arrangements	80
Eligible claims by retail clients	80
Compensation for licensee misconduct not investment losses	81
Insurance not a guarantee of compensation	82
Consequences where insurance does not respond	83
Nub of the problem	83
Possible remedial measures	84
Protection of consumers at the outset	85
Enhancement of insurance cover	86
More focus on financial adequacy of licensees	91
A last resort scheme for compensation	93
Issues in relation to any scheme	93
PFS/FOS scheme proposal	95
Other considerations	96

Attachment A: Relevant Corporations Regulations	99
Attachment B: Investor compensation arrangements in the European Union, Canada and the United States of America	101
Glossary	107

Consultation process
This consultation paper provides information, frames issues and raises questions on the need for, and costs and benefits of, a statutory compensation scheme for clients who suffer damage or incur loss as a result of misconduct by persons with whom they have dealt in the financial services sector. It was prepared as part of a review being conducted by Richard St. John. The paper reflects the initial research and preliminary consultation with industry participants and other stakeholders.
The reviewer invites feedback and comments from interested parties on the issues outlined in this paper. The information obtained through this process will inform and assist him in reaching views and making recommendations to the Government on whether changes are required to the current compensation arrangements. 
Electronic lodgment of submissions is preferred, with documents submitted in a Word or RTF format. An additional PDF version may also be submitted.
All information (including name and address details) contained in submissions will be made available to the public on the Treasury website unless you indicate that you would like all or part of your submission to remain in confidence. Automatically generated confidentiality statements in emails do not suffice for this purpose. Respondents who would like part of their submission to remain in confidence should provide this information in a separate attachment marked ’in confidence’. Legal requirements, such as those imposed by the Freedom of Information Act 1982, may affect the confidentiality of your submission.
Submissions may also be lodged by post.
Closing date for submissions: Wednesday, 1 June 2011
Details for making submissions
Email: futureofadvice@treasury.gov.au
Mail:  Statutory Compensation Review
 PO Box 6295
 Kingston  ACT  2604
Enquiries
Email: futureofadvice@treasury.gov.au
Telephone: Francesca Kibria (02) 6263 3253
Media Enquiries: medialiaison@treasury.gov.au
Outline of paper
•	This paper provides information, frames issues and raises questions on the need for, and costs and benefits of, a statutory compensation scheme.
•	Chapter 1 deals with the context and scope of the review. It also provides background on the overall regulatory framework for financial services and the regulatory philosophy on which it is based. 
•	Chapter 2 describes the current compensation arrangements within that regulatory framework.
•	Chapter 3 addresses the operation of those compensation arrangements in practice. 
•	Chapter 4 provides a comparison with compensation arrangements in other countries and industry sectors.
•	Chapter 5 provides some preliminary observations and draws out issues for further consideration.
•	Attachment A sets out relevant regulations.
•	Attachment B provides a summary of compensation arrangements in the EU, Canada and USA.