Do it once, get it right: wholesale regulatory intervention in price and cost disclosure

Transcription

1 Do it once, get it right: wholesale regulatory intervention in price and cost disclosure Nicholas Morris, Faculty of Law, UNSW, Sydney, Australia Rob Nicholls, UNSW Business School 25 th Colloquium of Superannuation Researchers UNSW Sydney, 6 and 7 July

2 Background The current situation in Australian Superannuation Fees and costs are not regulated. ASIC requires only limited disclosure of costs, at the retail level. ASIC's Regulatory Guide 97 excludes products such as annuities and selfmanaged superannuation funds. Permitted costs include insurance, for which the rationale is unclear. Costs incurred by entities to whom funds management is outsourced are not required to be disclosed. Practice in other regulated industries Prices are regulated unless competition is well-established. Focus of regulatory intervention is mostly at the wholesale level. Understanding and regulation of permitted wholesale costs helps regulators improve efficiency. Effective intervention by regulators reduces information asymmetry. 2

3 Why costs need to be disclosed and controlled Recent Rainmaker research suggests the cost of administering superannuation in Australia is about $31 billion. Removing the insurance component ($8.5 billion) still leaves around 100 basis points of the $2.3 billion of funds under management. This cost is in excess of 50% of the cost of the old age pension, and may exceed that amount once undisclosed funds management costs are included. So costs for one pillar of our system may exceed the whole of another pillar. In a world of shrinking voluntary contributions, this seems an odd balance. 100 basis points is a heavy burden in a world where the risk free rate is only 1.5%, and is high by international standards. In the absence of effective competitive pressure which might bring down these costs, it is worth exploring what type of regulatory intervention might work best to address the market failures of limited competition and asymmetric information. In doing so, we draw on many decades of experience in other regulated industries. 3

4 Competition or Regulation? Regulation is seen by many as a pre-cursor to effective competition, for example Littlechild 1983: Competition is indisputably the most effective perhaps the only effective means of protecting consumers against monopoly power. Regulation is essentially the means of preventing the worst excesses of monopoly; it is not a substitute for competition. It is a means of holding the fort until competition comes. Stephen Littlechild, Regulation of British Telecommunications Profitability (1983), para How to improve competition in superannuation is an important topic. For the present, however, we are concerned with how to make regulation more effective. 4

5 Five possible forms of price regulation Price cap (CPI-X) Establishes a decline in prices to reflect improving (productive) efficiency or the decline in costs arising from dynamic efficiency in the sector. Works well when there is a well-defined service or basket of services being priced. Rate of Return Works in three stages: (1) Elimination of unnecessary or imprudent costs; (2) Determination of a 'fair' rate of return (usually, the weighted average cost of capital); and (3) Setting of prices to generate enough revenue to provide that rate of return. In practice, there are significant issues with establishing both the reasonable costs of providing the service and the weighted average cost of capital of the firm. There is a risk of perverse incentives for a firm ( gold plating ). Performance-based Regulator sets a minimum (net of costs) performance standard, which requires an efficiency improvement to meet. Franchise Competitive price-based allocation to be the single default provider. [Productivity Commission] Benchmark Comparison with benchmark operators in other jurisdictions, or with a publicly-administered benchmark. Works well in combination with other forms of regulation. [Similar to Murray Report recommendations for prudential capital requirements in banking] 5

6 Retail or Wholesale Regulation? Where there is limited competition, there is an expectation of regulatory intervention at either wholesale or retail level. If supply of services at retail level is on an exclusive basis, then does need to be retail level But this is not the case in Australian Superannuation If retail level acquires services from a limited number of wholesale providers, then generally agreed intervention should be at the wholesale level This is the situation in Australian Superannuation Intervention at both retail and wholesale levels is normally regarded as extreme Better to do it once and get it right 6

7 The Need for Separation There may be significant problems in dealing with pricing intervention at either the wholesale or the retail level Because vertical integration makes it hard to allocate costs to either level (as with large financial conglomerates) Operational or Structural separation may then be necessary This approach has been used in electricity and other utilities in Australia and UK But hard to ring-fence within a single organisation, for example information movement or informal support cf Vickers Report in UK, and subsequent divestiture of parts of the major banks, eg Lloyds-TSB But raises the issue of a regulatory taking (acquisition of property by the government) However, solutions have been developed for telecoms in Australia 7

8 Fee Disclosure in Australia In February 2017 ASIC issued a new version of Regulatory Guide 97 (RG97) with the title 'Disclosing fees and costs in PDSs and periodic statements'. RG97 applies to issuers of superannuation products but not to annuities. Unclear why annuities have been excluded from the Australian regulations. In contrast, disclosure provisions are an integral part of the US National Association of Insurance Commissioners (NAIC) model regulations for annuities. If there is to be fee disclosure only at the retail level, it is necessary to have any of: i. wholesale fee disclosure; ii. iii. wholesale separation; or a combination of wholesale fee disclosure and separation. The crucial issue here is that there is little consumer protection provided by asymmetrically applied retail fee disclosure obligations. 8

9 Application of Utility Regulation to Superannuation One approach is to have a fixed fee mandate, perhaps with a two-part tariff, as already used in wholesale financial services. This would be similar to performance-based pricing. A first step could be removal of the insurance component of superannuation. Productivity Commission 2016 terms of reference did not cover this. Superannuation is not designed to provide legacy outcomes, and the law explicitly excludes such assets from a deceased persons estate. $8.5 billion is a high cost for a service that is not a core part of the product. Separation would require that superannuation trustees would be associated only with the retail aspects of the business. Excessive margins at the wholesale level could at least be identified through disclosure obligations. 9

10 Introducing Price Cap Regulation One approach might be to adopt a fixed payment methodology: Cost of superannuation must not exceed say $1.50 per member per day. This mirrors the methodology for measuring costs used by, for example, Super Ratings. Some efficiency improvements could be achieved by setting X=CPI, so requiring constant nominal costs. Or, as in some utilities (eg UK water), X could be variable across funds depending on measured performance (with the lowest performing funds facing a higher required X). Price Cap regulation could be replaced by Performance Based regulation as a transition out of price regulation. Most controls could be transferred back to the funds once adequate competition had been established. 10

11 Summary Costs of administering superannuation are too high, and need to be reduced. Market failures currently prevent competition from achieving this outcome so price regulation is needed. This regulation would be most effective at the wholesale level. Effective disclosure at wholesale level is necessary for such regulation. We have examined the application of five forms of price regulation that are used in the utilities sector to address market failures. These are: price cap regulation; rate of return regulation; performance based regulation; franchise regulation; and benchmark regulation. We have also looked at operational or structural separation between the retail and wholesale operations of businesses. 11

12 Conclusions It seems logical to follow these key steps: 1. Separate the provision of insurance from the superannuation sector. We suggest price-based allocation of the exclusive right to provide what would now be group insurance to Australians for a period. 2. Separate the wholesale and retail aspects of the superannuation sector in order to reduce implicit cross-subsidies and make them more transparent (or drive them out). 3. Encourage the industry to adopt fixed mandates or two-part mandates at the wholesale level that include payment for performance. 4. Until competition is demonstrated to be efficient, impose a price cap (expressed in absolute dollars, rather than percent of assets) to begin with. 5. Then adopt rate of return regulation after a period. 6. The subsequent withdrawal of pricing regulation can be by way of performance regulation. 12

13 Thank you Discussion and Debate 13