Defined Terms and Documents

Productivity Commission Inquiry into competition in the Australian financial system - Submission by ASIC - Sept 2017

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1 ASIC welcomes the opportunity to contribute to the Productivity Commission’s inquiry into competition in the Australian financial system, its consideration of what competition in the Australian financial system should look like, and the challenges that need to be overcome to ensure competition is working as effectively as possible.

2 We consider that the fundamental purpose of competition in markets for financial products and services is to enhance the long-term interests of the end users of the financial system. Rather than competition occurring for its own sake, competition should drive markets to meet consumer needs and preferences.1

3 However, we have observed that competition appears to operate less effectively in some of these markets than others.

4 In particular, persistent problems in a market—such as inefficient pricing and excess profits, poor service and deteriorating product quality, leading to poor consumer outcomes—can be a sign that competition is not working as effectively as it could be.

5 For competition to work in the interests of consumers, both supply and demand sides must work well, in a ‘virtuous circle’. However, various forces can weaken or impede competition, and the virtuous circle can be fragile.2

1 I Harper, P Anderson, S McCluskey & M O’Bryan QC, Competition policy review, final report, March 2015, p. 7.

2 UK Office of Fair Trading, What does behavioural economics mean for competition policy? (PDF 344 KB), March 2010. This work has been subsequently built on by Amelia Fletcher.

6 Competition laws are an essential underpinning of effective competition in markets for financial products and services, as for any other market. However, in our experience, the cause of consumer problems relating to financial products and services is generally not the kind of behaviour that would clearly breach competition laws (e.g. cartel conduct or misuse of market power). Rather, many current competition issues in markets for financial products and services are derived from the nature of the markets themselves, and often require a tailored regulatory approach.

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7 There are a number of factors that may make it more difficult for competition to effectively operate in markets for financial services and products than in other markets. These include: (a) the ‘credence’ quality of some financial products and services, which means suitability and quality are hard to gauge before or even after purchase;

(b) asymmetric information and power between providers, intermediaries and consumers;

(c) the inherent risk and uncertainty, and complexity, of many financial products and services; and

(d) the fact that financial products are an infrequent purchase, and it may be more difficult to shop around and exert competitive pressure.

8 Additionally, even where industry recognises that particular practices are producing poor consumer outcomes, ‘first mover’ disadvantage and the difficulty of collective action means that regulatory intervention will be required to address the issue.

9 For consumers to exert demand-side pressure that drives effective competition they need to be able to: (a) access information about the products and services available in the market;

(b) assess the information available about these products and services to compare them; and

(c) act on this information by purchasing or switching to a product or service that offers the best value to them.3

10 However, evidence and insights from the behavioural sciences show that there are much more complex factors that can affect consumers’ interaction with information and their decision making. A significant body of work by policy makers, academics and regulators has been built over recent years

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11 These factors are particularly relevant in the context of the retail financial services sector, which is recognised as a rich environment for behavioural factors to affect individuals’ decision making, including because of the impact of the inherent features of financial products and services described in paragraph 7 and in Table 2.

12 There are a range of factors that may limit supply-side competition from working effectively in markets for financial products and services, as in all markets, including where there is low ‘contestability’ and high barriers to entry, and a lack of transparency in the provision of products and services.

13 However, the presence of behavioural biases and other factors weakening demand-side competition (e.g. lack of financial capability) could also provide opportunities for firms to exploit these to maximise profit, particularly where their interests are misaligned with those of consumers (e.g. conflicted remuneration structures).

14 In our regulatory experience, financial products and services warrant a specific regulatory regime to promote effective competition, especially in retail markets.

15 Regulation and regulatory oversight must be well designed and executed in order to enhance competition, rather than reduce it. However, we think there is no necessary trade-off between regulation and facilitating competition, or between competition and consumer protection.

16 While the objectives of financial system regulation are similar to those applying in all markets (i.e. to prevent a range of possible market failures), the means of achieving them often needs to take specific forms due to the nature and complexity of markets for financial products and services.

17 Thinking on the best way for regulation to promote competition and good consumer outcomes has evolved over time through major inquiries into, and regulatory changes to, the financial system.

18 At a general level, a key underpinning of financial regulation, established through the 1997 Financial System Inquiry (Wallis Inquiry), has been that

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19 Nevertheless, both before and after this inquiry, more interventionist regulatory approaches were in use for specific markets and products to address significant market failures affecting consumers. This is particularly so for mass-market products (e.g. consumer credit and insurance products), where regulation has long intervened directly into product design or distribution. (e.g. prohibitions on particular contract terms for credit or insurance products).

20 The 2014 Financial System Inquiry (Murray Inquiry) established a shift in regulatory philosophy away from a reliance on disclosure to address market problems, towards using regulation as a tool to actively promote fair consumer outcomes and effective competition.

21 We strongly support the recommendations of the Murray Inquiry to expand ASIC’s regulatory mandate and toolkit, to provide us with a means to better analyse and respond to competition issues: see paragraphs 28–29.

22 ASIC is the market conduct regulator for the Australian financial system.

23 While we are not a competition regulator, our regulatory framework, policies and decision making play an important role in shaping competition in the financial system. Where possible, we consider competition in carrying out our work, although it is not currently a primary feature.

24 We maintain a strong working relationship with the Australian Competition and Consumer Commission (ACCC), as the national regulator responsible for competition law.

25 Understanding the inherent features of financial products and services, and the supply-side and demand-side interactions described in paragraphs 72–85, helps inform the type of regulatory interventions that may be most appropriate to address specific market problems.

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26 To address competition weaknesses and promote effective competition, we think the most appropriate response is to craft tailored regulatory solutions that are appropriate to address such complex dynamics, which may involve: (a) dealing with barriers to effective demand-side competition (e.g. by better informing consumers about the choices available to them, or more effectively overcoming behavioural defaults that are not in consumers’ interests); and/or

(b) addressing structural issues on the supply side that are leading to poor consumer outcomes (e.g. by removing conflicts of interest that are leading providers to exploit demand-side weaknesses).

27 ASIC’s submission highlights various current or potential future reforms that we think are likely to address specific competition weaknesses, or promote effective competition, more generally: see Table 1.

28 In particular, we believe the recommendations of the Murray Inquiry to expand ASIC’s regulatory mandate and toolkit provide us with a means to better analyse and respond to competition issues. These recommendations, which the Government has committed to implement, are for: (a) an explicit and broad competition mandate for ASIC, to ensure we have a clear basis to consider and promote competition in the financial system; and

(b) new product design and distribution obligations, and a product intervention power, to help address market failures that lead to poor consumer outcomes.

29 In combination, these tools will: (a) enable us to evaluate and take into account a range of competition factors that result in market problems, including demand-side factors;

(b) enable us to effect targeted and evidence-based change to address market failures and market-wide problems more quickly than law reform;

(c) deal with ‘first-mover’ problems that may inhibit industry-led responses to market failures; and

(d) help promote competition, and not act as a barrier to entry.

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 The Hon Kelly O’Dwyer MP, ASIC enforcement review taskforce, media release, 19 October 2016.
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Priority Description

Sector-specific reforms
This could include various sector-specific law reforms that are open to and/or could promote competition, including:  the distinction between general and personal advice; and  a Government commitment for law reform to grant ASIC rule-making powers and the ACCC arbitration powers in relation to market-driven competition outcomes in clearing and settlement facilities. Note: See Table 6.
 

Ongoing monitoring
Ongoing monitoring of competition in the financial system by ASIC and the ACCC would support the above measures. This would include increased focus on demand-side competition issues and tailored remedies to address them (e.g. more targeted and useful disclosures or reviewing product design features).
ASIC’s

ASIC’s submission 30 This submission discusses: (a) competition in the financial system and ASIC’s role, and potential regulatory responses to address competition issues (see Section A); (b) observations about the supply-side market dynamics that provide a backdrop to understanding the environment in which consumers operate (see Section B); (c) insights into how consumers think and behave, which help us understand competition problems in retail markets for financial products and services (see Section C); and (d) regulatory approaches to facilitate effective competition in the financial system (see Section D).
31 Appendices are also attached in a supplementary volume to this submission. These describe some of the key markets we regulate of interest to the inquiry, and particular issues relating to competition within them.

A Competition in the financial system and ASIC’s role
Key points
Competition has a key role to play in ensuring the efficiency, integrity and growth of the Australian financial system. We consider the fundamental purpose of competition is to enhance the long-term interests of the end users of the financial system. For competition to work well for consumers, both supply and demand sides must work effectively. However, there are a range of supply-side and demand-side factors that can impede and cumulatively weaken competition in various markets within the financial system. Competition operates less effectively in some of these markets than others. Even where there is significant competition, there may be specific issues than can or should be addressed to enhance its effectiveness. Regulation supporting both market integrity and consumer protection is necessary for effective competition in the financial system. ASIC regulates market conduct in the financial system. While we are not a competition regulator, our policies and decision making can play an important role in influencing competition in the financial system. An explicit and broad competition mandate focused on the long-term interests of consumers, and the ability to make tailored interventions to address areas of market failure adversely affecting consumers, will better enable ASIC to promote competition in the financial system.
Purpose of competition 32 Competition has a key role to play in ensuring the efficiency, integrity and growth of the Australian financial system. It can provide better and more efficiently priced products for consumers, and facilitate increased funding and investment for businesses, and financial wellbeing for all Australians.
33 We consider that the fundamental purpose of competition is to enhance the long-term interests of the end users of the financial system.
Note: In this submission, we have generally used the term ‘consumers’. This term broadly includes the customers and users of financial products and services, and may, depending on the context, encompass wholesale (including institutional) and retail investors, small to medium enterprises (SMEs), and large corporations.
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34 Rather than competition occurring for its own sake, competition should drive markets to meet consumer needs and preferences.5
35 In theory, well-informed, confident and effective consumers play a key role in activating vigorous competition. In response, these demand-side factors should provide firms with incentives to deliver products and services that are fit for purpose by competing on price, service and quality.
36 For competition to work in the interests of consumers, both supply and demand sides must work well, in a ‘virtuous circle’. However, various forces can weaken or impede competition, and the virtuous circle can be fragile.6 Regulators, market infrastructure providers, product issuers, distributors, investors and other consumers all play an integral role in shaping effective competition in the financial system.
Competition and poor consumer outcomes in financial markets 37 Persistent problems in a market—such as inefficient pricing and excess profits, poor service and deteriorating product quality, leading to poor consumer outcomes—can be a sign that competition is not working as effectively as it could be. 38 The Competition policy review found that: Competition policy is aimed at improving the economic welfare of Australians. It is about meeting their needs and preferences by making markets work properly.7
39 Within the broader competition policy framework, competition laws are an integral instrument for regulating particular types of conduct that are anticompetitive.
Note: Paragraphs 107–110 set out information on the respective roles of ASIC, as the market conduct regulator, and the ACCC, as the competition law regulator, in relation to competition issues in the financial system.
40 The overarching objectives and requirements of competition laws are an essential underpinning of competition in markets for financial products and services as they are in other markets. However, in our experience, the cause of consumer problems relating to financial products and services is generally not the kind of behaviour that would clearly breach competition laws (e.g. cartel conduct or misuse of market power). Rather, many current competition issues in markets for financial products and services are derived

5 I Harper, P Anderson, S McCluskey & M O’Bryan QC, Competition policy review, final report, March 2015, p. 7. 6 UK Office of Fair Trading, What does behavioural economics mean for competition policy? (PDF 344 KB), March 2010. This work has been subsequently built on by Amelia Fletcher. 7 I Harper, P Anderson, S McCluskey & M O’Bryan QC, Competition policy review, final report, March 2015, p. 7.
Productivity Commission Inquiry into competition in the Australian financial system: Submission by ASIC

from structural problems in the markets themselves, and often require a tailored regulatory approach.
41 A tailored solution may involve, for example: (a) dealing with barriers to effective demand-side competition (e.g. by better informing consumers about the choices available to them, or more effectively overcoming behavioural defaults that are not in consumers’ interests); and/or (b) addressing structural issues on the supply side that are leading to poor consumer outcomes (e.g. by removing conflicts of interest that are leading providers to exploit demand-side weaknesses).
42 Most often, we have observed that a tailored market-wide regulatory response will be required because a practice producing poor consumer outcomes will not change unless the whole industry acts to change it. Generally, it will be difficult for industry to agree to voluntarily change a practice collectively and, in any case, competition law may prevent such action.
43 Individual firms may understand there are practices that are producing poor consumer outcomes but cannot address them through individual action because of the ‘first mover’ disadvantage of doing so.
44 Further, demand-side behaviour in many of the industries we regulate exacerbates this situation, because the demand-side cannot exert sufficient pressure to incentivise firms to change their practices.
Note: See paragraphs 64–67 for further details on ‘first mover’ and collective action problems.
45 These include significant barriers to effective demand-side competition. It is difficult for end users in financial markets to exert effective demand-side pressure due to factors such as the inherent complexity of some financial products and services, and the ‘credence’ quality of some financial products and services, making them inherently difficult for consumers to assess even after consumption.
Note: See Table 2 for further details on how the inherent nature of financial products and services affects market dynamics and competition in the financial system.
46 Additionally, the significant role that intermediaries play may mean that providers are directing competitive energy at securing distribution channels rather than directly attracting consumers. Here, competition is intense, but in many cases may not be not working in the interests of end users.
Note: These issues are described further in Section B, paragraphs 152–155.
47 It is in such circumstances—where a practice risks significant harm to end users, but there is minimal demand-side pressure for change to occur—that
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we see a product intervention power for ASIC being most effective, to allow us to construct a tailored response to the problem: see paragraph 114 for more details about the proposed product intervention power for ASIC.
Effective competition 48 The ultimate purpose of competition in the financial system should be to promote the long-term interests of consumers—that is, competition should be ‘effective’.
49 However, the financial system is made up of complex and diverse markets. A range of demand and supply factors can impede and cumulatively weaken effective competition in the financial system.
Note: In limited cases (e.g. critical centralised financial market infrastructure), the introduction of competition can impose material additional costs or introduce externalities affecting consumers beyond the actual user of the financial infrastructure, and effective competition also needs to adequately account for these factors.
Role of suppliers 50 From the supply side, effective competition occurs when firms actively compete on price, quality and service to win customers and maximise profit, are driven to invest in products and services, and innovate to meet changing consumer needs and preferences.
51 However, there are a range of factors that may limit supply-side competition from working effectively in markets for financial products and services, as in all markets. These include where there is low ‘contestability’ and high barriers to entry, and a lack of transparency in the provision of products and services. Further, a firm’s interests may not always align with the best interests of consumers.
Note: These issues are described further in Section B.
52 As discussed in Section C, the presence of behavioural biases and other factors weakening demand-side competition (e.g. lack of financial capability) could provide opportunities for firms to exploit these to maximise profit. Technology also provides opportunities for firms to, for example, segment the market and engage in price discrimination in a way that negatively affects consumers.
Role of consumers 53 Consumers are both the beneficiaries, and key drivers, of effective competition.
54 Where competition is working effectively, consumer welfare is enhanced through more efficient prices, better quality products and standards of

Case study: Credit cards in Australia
A senate inquiry submission by Treasury noted that in 2013 only 30% of surveyed users reported paying interest on their credit card balance.98

Contrary to this self-reporting though, the share of balances attracting interest at the time was in fact closer to two-thirds.99

Consumers with strong present bias or over optimism may set out with the expectation and intention of always paying off their balance in full.

Believing they will not incur any interest, these consumers may instead choose cards based on features with more immediate benefits such as balance transfer periods or rewards points, rather than key cost drivers such as annual fees and interest rates.

A 2015 Choice survey found that 29% of customers who switched in the last two years did so for an interest-free period and another 29% of this group switched for a balance transfer deal.100

Although consumers may benefit from initial deals, concerns arise when:

•          Consumer intentions are not matched by actual behaviour over time and interest and/or other fees are in fact incurred. The 2015 Choice survey found over 64% of respondents did not know their interest rate and 54% said they did not know or answered incorrectly when asked about what the minimum monthly payment meant.101

•          These initial benefits expire and cards revert to much higher rates and fees, but consumers fail to switch.

The 2015 Choice survey found only 11% of consumers reported switching in the last two years, with 72% not having considered switching at all, and 17% reporting they considered switching, but had not done so.102

Competition is distorted when firms respond to consumer behaviour by competing on these upfront ancillary features whose benefit may be eroded or even reversed for the consumer over time, rather than competing on key cost drivers. The low rates of switching when these benefits end and credit cards revert to high annual fees and interest rates suggest consumers may suffer from low awareness or understanding of product features and their own spending tendencies as well as inertia.
 

As previously noted, financial products and services often have high levels of underlying complexity, and can involve elements of risk or uncertainty, which consumers have to try and factor in to their decision making. Where
 

98 Treasury, Submission to the Senate Economics References Committee Inquiry into matters relating to credit card interest rates, 11 August 2015.

99 Ibid.

100 Choice, Cutting credit card confusion: Submission to Senate Economics References Committee—Matters related to credit card interest rates, 2015. 101 Ibid. 102 Ibid.
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firms have bundled products it can make it especially difficult for consumers to separate and assess the value of each part individually.
317 The traditional mechanism relied on to facilitate consumer understanding of these product features has been mandated disclosure documents, which are often long and technical.
318 This complexity of products and the technical nature of disclosure documents can increase consumers’ cognitive load when assessing information about products they are considering. Having to process too much information can lead to a reduction in the quality of decision making.
319 These effects can be compounded by the timing of when information is provided to consumers. The same information provided at different times can have differing effects on people’s propensity to read and understand it, and effectively account for it in decisions. It is important that consumers receive the right information (and other prompts relating to products and services) at the right time to be able to better assess their options.103
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