Transcript Remarks to a panel discussion at the Thomson Reuters' 2nd Australian Regulatory Summit

Well welcome everybody and welcome to this session, the Future of Financial Regulation in Australia. I thought I'd actually join our panellists down here on these comfortable seats for this session. These are indeed interesting times, in the years following the GFC we've seen literally a tsunami of regulatory change sweep across the world, involving extensive regulation of financial institutions, financial products, markets, and in some ways Australia has been spared from many of these changes, but with developments in technology the world continues to become smaller and as regulators continue to seek to extend their reach across their borders. So if we look at Australia for the moment we've obviously just passed a landmark point with the Financial System Inquiry, which is taking place in an environment 17 years since the Wallis Inquiry and David Murray and his team have received over 270 submissions to date. They've been involved in apparently more than 100 stakeholder meetings and have the unenviable task of somehow bringing that altogether into a coherent set of frameworks for the future. So I think you'll agree that the timing is ideal for this panel and discussion on where Australia should be going forward. So each of our panellists brings a unique perspective to this debate, and we will spend the first half of this session or so in a discussion up here before taking questions from the floor, so without further ado I'll hand to the panel and ask Luci Ellis if you could give some comments and perspective, particularly on Australia in the context of the G20 and then moving on to the FSI.

Thanks for that Jason and thanks very much for having me. I think yes it is a big regulatory reform process that involves a huge number of areas and a number of different regulators in each jurisdiction, but I think it's safe to say that the overall design of the regulatory reform process that we've seen since the crisis has been completely inspired by the lessons of the crisis and has been directed to the weaknesses and the things that we learned through the crisis. What are the things that we learned; I mean banks needed to be safer, they needed more capital, they needed better quality capital, they needed better funding profiles, and that was a global picture. And at times when things did go wrong and a bank or another financial institution or infrastructure needed to be resolved the resolution tools available needed to be more flexible. We needed to be able to resolve an entity and not have a full government bailout being the only option available to us. I think it's also the case that we needed to make sure that over the counter derivative markets were safer, I think there were a number of issues shown there, particularly in credit default swaps, but not only in credit default swaps, that over the counter derivatives markets were not functioning in with the level of safety that was needed in order for that particular market to serve its purpose and I think also risk from shadow banking needed to be better understood and better managed and when you think about how the crisis played out I mean in the end there were a lot of banks that were in trouble but a lot of it was due to the fact that they had related entities that were outside of the regulatory perimeter that were where all the risks were and that were actually not being regulated or oversighted by anyone, including apparently the management of the overall financial group; thinking AIG built up enormous exposures in over the counter derivative markets in an unregulated non-insurance part of its business and they're the things that are important in shadow banking. And so those four heading, safer banks, resolution, OTC derivatives, and shadow banking are really the four key parts of the post crisis regulatory reform and they're the four key elements that Australia has emphasised as G20 in its G20 Presidency year, and I think the view that we've taken has been there is actually an enormous program of work that has already been agreed, we should get on with completing that work, and we should have a very high bar for adding anything new to the agenda, because it's nearly – that's what more than six years now since the beginning of the crisis and coming up for six years since the peak of the crisis in 08, and honestly if you haven't thought of the idea yet, it probably wasn't that important. So I think the view of Australia as G20 Presidency, has been this is what we've agreed to, it turns out some of that is an enormous amount of work and there's a lot very technical work that has to happen, legal issues that have to be sorted out, data issues that have to be sorted out, I think that's been under appreciated and so we want to get on with that and complete the work that we've already agreed. And I think that also – that view of the authorities in Australia also informs what we've said with the Financial System Inquiry, and if you look at the Reserve Bank submission, one of the things we said was actually in Australia the arrangements of who does what, is working pretty well, we have very good relationships and we have already agreed to an awful lot of reforms and there are still a few bits and pieces that need to be completed on those and so we would like to be allowed to get on with that, and complete what's already been agreed.

Thank you, technology was mentioned a few times and data, just in terms of the pace of change and markets and so forth, I'd be interested in your views Oliver on technology in particular and how you cope with the pace of change.

Thank you Jason. I think your point's a very valid one, we've seen an exponential growth in the complexity in the Australian financial market place, particularly over the last several years and I think there are a couple of drivers sitting behind that, the technology is absolutely probably the main and primary driver. A number of regulatory decisions in particular that facilitated lowering the barrier of entry in addition to what technology is already providing and has increased competition both in domestic sense and in an international sense as well, and I think Luci touched on something that's very real for us as an agency regulating the domestic context but very much internationally – very much influenced internationally by what's going on overseas and our capacity to introduce domestic settings that best serve investors and capital raises in Australia at the same time trying to manage our place in the international community and implementing change here that sits neatly with international expectations and those of our domestic community.

Would you like to comment?

Yeah look I would completely endorse what Oliver was saying but if anything – if it's any comfort Rebecca I mean we feel your pain in terms of the IT and regulatory change and what that means, and I think I can give two examples that even in the Reserve Bank we're having to spend lots of money and build big systems to deal with our side of the regulatory reform process, and I can think of two examples that are quite important one of course is no Australia simply doesn't have enough government debt to run the liquidity coverage ratio in the way it was originally designed, fortunately the Basel committee was sensible enough to realise this and there is a particular element of the LCR rules that allow countries like Australia to use a committed liquidity facility with the central bank as an alternative to having a whole bunch of government bonds that simply aren't there as your liquid assets. Of course that then means we need to think about what it is that we will accept in the committed liquidity facility, that then means well some of the things we'd have to take because there aren't enough government bonds is self securitisations, that means we need to comfort ourselves with the asset quality behind those self securitisations and that means we need loan level mortgage data and a whole bunch of information. Well of course what does that mean; a ginormous database and a whole bunch of processes, and similarly over the counter derivatives, one of the key stone elements of the post crisis regulatory reform. I think one of the good things about the regulatory reform process that's happened globally is we haven't just said oh we're going to write all these rules that say though shalt do this, though shalt not do that, it's not just been regulatory, a lot of its actually been about reporting, so that regulators can see the risks as they might arise, because we all know that the next crisis isn't going to look exactly like the last one, and so there's been a lot of focus particularly in our over the counter derivative markets but also in shadow banking around getting information, so of course all of the over counter derivatives and Westpac will be one of the entities that are now reporting, their over the counter derivatives exposures and transactions to trade repositories, well again the reason for that is so that the regulators can actually see what's going on and work out if there are any risks that need to be responded to. Again big enormous database, huge numbers, big IT spend, I think it's fair to say that both the industry and the regulators are facing this challenge at the moment and technology and revamping your systems and doing it in the most efficient way possible is absolutely the priority on both sides and I think there's a lot of synergies there. Of course that means we're competing for the same staff.

With the time that we've got together here now I'd actually like to spend some time on extraterritoriality, because I think that's going to be a big – a big issue or continue to be a big issue going forward, and I'd be interested in the panel's thoughts, I might start with you Luci in terms of how you think we're coping with extraterritoriality as its evolving and potentially where it might get too.

Thanks for that Jason. I think post crisis regulatory reform agenda really was the high point in international cooperation and standardisation for regulatory reform and I think that was really what we should continue to aspire to, but it is the case that well firstly there is a good principle that actually if countries want to be a little bit more conservative than what the global rules require they should be allowed to do so and in Australia the authorities have always held to the principle that countries should be able to tailor appropriately to their national circumstances and I think again the committed liquidity facility is an example of that, and so is some of the minor details are within APRA's implementation of Basel III more broadly. But on the other hand you want to be able to offer substituted compliance, you want to be able to allow banks and other institutions to play in a global market place with some degree of certainty and that means offering substituted compliance based on the global rules, what's been globally agreed, rather than saying do you line by line, accord with what we've done here in our country are your rules exactly the same as ours, and I think that's something that some of the countries globally haven't yet quite got to grips with. I think one of the other things is of course that within the countries that were most effected by the crisis I think you have wanted to do more in terms of reforms, and it's interesting that when people complain about regulatory burden and all the re-regulation that's happened, it's like well what are the things that are really bothering you, and it's like well FATCA and Dodd Frank, and it's like well we can't really help you with those. Act in some respects if you want to play in the US market you have to play by US rules, if you want to play in the Australian market you have to play by Australian rules and I think finance is really the only industry that I'm aware of where, as well as having technical standards that are globally agreed, we're attempting to have regulatory standards that are globally agreed. I mean we're trying to have common standards around over the counter derivatives but you don't have that for over the counter medicine. As anyone who's looked at the dosage requirements for lots of over the counter medicines we don't say well here in Australia we'll take substituted compliance and take on what the UK NHS says, and at the risk of exposing a personal hobby horse we don't say what's good enough for Swedish babies is good enough for Australian babies and we'll take the European child seat rules. Well I'm sorry we've chosen quite a lot of safety at the expense of a certain amount of inconvenience in those areas, finance is the only one and anyone who's actually tried to switch one of those car seats over when you've had your car in the repair shop, I mean now there's a regulatory reform I could really agree with. But finance is really the only area, we live in a globalised market, we have globalised supply chains right round the world, but every country has its own regulatory standards for pretty much everything else, finance is the one industry where we go to all that effort to have globalised rules, and it doesn't always come out fully globalised but I think the principle that substituted compliance should be offered on the basis of compliance with the global standard rather than the specific wording of your national regulation I think is an important one.

What do you think, do the regulators do well enough talking to each other or do we need a super regulator?

Well my frequent flyer statement does say that we're doing a lot of coordination in talking to each other. I think it's an interesting idea and obviously enforcement does require early access to data and where I think the challenges in that idea come from are exactly the same challenges that we're facing on the OTC derivatives space where it's been acknowledged that for example we need a data hub internationally to look at the exposures of the globally systemically important banks and whether they're exposed to each other, there's different layers of national regulators get the national transactions and exposures but other countries don't necessarily get that institution level detail, but then there are processes for particularly the globally systemic institutions having exposures. And then there's a huge amount of legal change that has to happen to allow regulators in one country to allow that institution specific information to be shared with other regulators, and so there's a huge program of work to actually allow that to happen, there's a special data room in Basel that's actually collating all these details, and it's actually hugely legally complex and it requires legislative change in a number of countries and just to give a perspective in Australia we can in particular APRA can, give permission to other agencies to share data at an institution level internationally and that's a lot of how things work with the Basel committee process we have these quantitative impact statements we do cost benefit analysis that involves bank level data, again confidentiality agreements have to be maintained. Getting all that process, and it's very careful we then, if there's someone from a research department of an international agency says oh it would be really cool if I could have that data and write journal articles using it, and it's like well no that's not what it's for. So there's a huge legal process to have that information sharing, and so again the principle is really clear but don't under estimate the legal hurdles and you said maybe within 10 years.

Absolutely.

Or at least 10 years to get all that right.

Hi I'd be interested in the panel's view on the current regulatory perimeter in Australia. Shadow banking has been mentioned a couple of times but are there any particular areas of concern relevant to the Australian market given where the boundary of the prudential net is currently drawn.

Taking up your point about shadow banking specifically, I think there are two related reasons why the global regulatory agenda has included an element of shadow banking. I mean one is obviously the relationship between shadow banking and what went wrong in the GFC and cleaning up those specific things, but there's also a clear recognition that if you're doing a lot to make the prudentially regulated sector safer, you do risk over doing it and then a lot of the activity moving out to the unregulated sector and we have the 1970s all over again, and the global regulatory community is very aware of that, and I think that's where again this is we're about monitoring as well as regulation, so a lot of the regulatory reform that we're talking about is actually about getting more data observing where the risks lie. In the Australian case what you could reasonably describe as shadow banking and particularly the finance companies money market corporation side of the picture is actually really small and declining and so we've also put the view in international forums that again the regulatory response should be proportionate to the risk, and so we've not had a lot of appetite to suddenly go in and re-regulate a whole bunch of things that really don't warrant it, and so for example one of the things that went really wrong during the crisis was in the US money market funds had runs. Well the reason they had runs was because they were allowed to have a stable net asset value offered to customers, so they could give you a deposit like instrument while not actually having deposit like regulation and in the Australian environment that wasn't how it works. If you become illiquid you have to freeze, Corporations Act says so, and in Australia the system worked because you couldn't get a run going on a non-deposit non-ADI because the way the Corporations Act works says you can't offer stable net asset value, you can't offer instant liquidity if you're not a deposit, and so our functional regulatory system actually worked and didn't have this kind of issue that the US had with its money market funds, just the way the system was set up was different and of course the equivalent space in Australia was much smaller in any case. But importantly it was regulated differently, so we've always said it's got to be proportionate but yeah we are very alert to that.

Just got a question relating to macro prudential supervision and in the context of high LVR limits imposed by the RBNZ in New Zealand which by all accounts they seem to be relatively happy with the outcomes, just wanted the panel's views on the prospects and merits of similar types of macro prudential supervision in this market.

Well that one's kind of obviously mine isn't it? The Reserve Bank and APRA have already put out their position on what macro prudential means in the Australian context, there's a paper that we put out in what was it 2012 which was also done in the context of the IMF FSAP and I mean our view is that macro prudential is subsumed within our broader financial stability framework and given that it contains the word prudential we're talking about what APRA can do and I think there's been a lot of people around about saying well why won't the Reserve Bank do something it's like because they're APRA's powers and APRA's perfectly capable of making macro prudential assessments. APRA has a mandate that is about the system and financial stability I think that's not true for a number of other jurisdiction, there's been a lot of misconceptions about well the problem was we had these prudential regulators that were micro prudential and just focussed on safety and soundness of individual institutions and that's why they missed all these risks. I mean the first problem with that view as well if the mandate's wrong fix the mandate. And the second problem with that view is actually a lot of what went wrong in the US was actually micro prudential failure, there was just a complete failure in lending standards and credit practices in the US in their mortgage market. So it's not clear to me that you actually needed a macro prudential view point there. I don't necessarily want to get into specifically what the New Zealanders have done, other than to point out they have also raised interest rates so it's going to be very difficult to disentangle what actually has had an impact on the housing market there in recent months, was it the interest rates or was it the LVR limits, it's really hard to tell. And I guess the viewpoint that I would have is that your regulatory response or your policy response should be targeted to the risks you actually face, if you have a headache you do not bandage your arm. And so I mean certainly in Australia we haven't actually seen, we have data on this, and data is really important, there is an international language or statistical definitions on lending standards and this is something that in Australia we've been very focussed on and tried to rectify and how very important it is for banks to report their LVR stats that they do every quarter and that APRA publishes and we draw graphs of in every financial stability review and what that tells you is that actually there hasn't been an increase in high LVR lending in Australia. So if you're concerned about risks in your market look at the things that actually appear to be growing in the risk that they pose and in the specific circumstances in Australia high LVR lending, you may take a view that it ought to be lower but it's not something that has been increasing in risk. So were we to consider a particular regulatory response or policy response to a risk in property markets generally, a high LVR limit is not the one that would seem most calibrated to the kind of risks we face in Australia at this point. But again this would be a judgement by APRA and there are a number of different tools in its toolkit, this has been discussed publicly in a number of other places, the Governor mentioned in one of his recent public appearances that we have thought about how to do this, check FOI disclosure logs for some of the things that we've said and that I've said about this, but you should really look at the kinds of things that are actually, the risks that are actually being posed, so yeah I think that would summarise it but we've said a number of things about that publicly already.