Does the finance industry need a compensation scheme of last resort?

The compensation scheme, intended to assist consumers who suffer loss from financial services entities, is yet to be established – is it a good idea?

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry called for a compensation scheme of last resort.

David Locke

CEO and chief ombudsman, Australian Financial Complaints Authority (AFCA)

David Locke.The short answer to this question is yes, absolutely.

AFCA and its predecessors have been long-standing advocates for a compensation scheme of last resort. It is a necessary backstop that ensures that people who have been the victims of misconduct and who have lost out through no fault of their own, are properly compensated and get justice.

AFCA was established on 1 November 2018 as a free one-stop-shop that consumers and small business owners can use for fair, independent and effective solutions to their financial disputes.

In the first five months of operation, we received almost 30,000 disputes and awarded more than A$67 million in compensation.

However, awarding compensation is not enough. We must also ensure that it is paid.

An external dispute resolution mechanism is clearly not satisfactory for a consumer or a small business if the financial firm fails to comply with a binding determination in the complainant’s favour.

“An external dispute resolution mechanism is clearly not satisfactory for a consumer or a small business if the financial firm fails to comply with a binding determination in the complainant’s favour.” David Locke, AFCA

Consumers and small businesses have a reasonable expectation that they will receive compensation when it is awarded. However, the Ramsay Review (into the dispute resolution and complaints framework) found that there was clear evidence that this expectation is not being met.

A compensation scheme of last resort will address this and ensure consumers and small business owners are properly compensated.

Keddie Waller

CPA Australia manager, Public Practice

Keddie Waller.A scheme to assist those who have been deceived or misled is a good thing. The question is who pays for it and should all investors be levied the same rate, irrespective of the risk they take on?

A levy on all investment products may cause inequitable situations where investors in conservative or low-risk investment products or major institutions are funding a scheme they may never use and that is more likely to be used by investors in riskier investment products. Conversely, a levy on particular products could mean prohibitive costs for individual investors.

Depending on the make-up of such a scheme, the potential moral hazard must also be considered. Investors may be encouraged to make riskier decisions and product providers market more high-risk products if they believe they may be compensated if their investments fail.

This kind of scheme may also prevent investors who take risky advice from being accountable for their decisions. If the scheme is funded by a levy on Australian Financial Services (AFS) licensees, it is important to consider the impact on the practices that provide valuable advice, who will essentially be subsidising those who fail to maintain adequate professional indemnity (PI) insurance cover or provide poor quality advice.

“This kind of compensation scheme may also prevent investors who take risky advice from being accountable for their investment decisions.” Keddie Waller, CPA Australia

The Ramsay Review found that not all AFS licensees were meeting their insurance obligations, so some consumers and small businesses were not receiving their EDR [external dispute resolution] awards. Given this, perhaps in the first instance AFS licensees who rely on PI Insurance to meet licensing obligations should be required to provide additional information to ASIC to enable better surveillance. This could reduce the risk of a licensee failing to meet obligations, while increasing the chances of an EDR award being paid.

Gerard Brody

CEO, Consumer Action Law Centre 

Gerald Brody.People who’ve been exploited shouldn’t be left to pick up the pieces alone. 

That’s why the federal government’s long-overdue announcement that it would establish a compensation scheme of last resort for the finance sector was so important.

The announcement was made in February 2019 as part of the government’s response to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. The Royal Commission revealed publicly the impact of uncompensated loss – the personal hardship suffered by people who were left out of pocket as a result of misconduct in the finance sector.

The financial services regulatory framework promises that people who have suffered loss should be compensated. However, there has long been a significant and unjustified hole in the framework. Where a financial firm goes out of business, people can be left out of pocket even after they have successfully obtained an ombudsman or court order in their favour. This is not only unfair for those affected, but it breeds distrust in the rest of the community. The feeling is that the system is rigged against us.

“Uncompensated loss is a huge problem. This is about families losing their houses, being driven to poverty, or facing extreme mental anguish.” Gerard Brody, Consumer Action Law Centre

Uncompensated loss is a huge problem. This is about families losing their houses, being driven to poverty, or facing extreme mental anguish.

When the scheme is established, people will know for the first time that if their financial services provider does the wrong thing and is required to provide compensation, they will be paid and not left out of pocket.

Meet the experts

David Locke
David Locke is the chief ombudsman and CEO of AFCA, which provides fair, independent and effective external dispute resolution services for small businesses and consumers with complaints about financial firms. Prior to this role, Locke was assistant commissioner of the Australian Charities and Not-for-profits Commission.

Keddie Waller
Keddie Waller is manager, public practice at CPA Australia. She is responsible for the development, servicing, representation and compliance of CPA Australia public practice members. 

Gerard Brody
Gerard Brody is CEO of the Consumer Action Law Centre, an independent, not-for-profit consumer organisation that provides financial counselling, legal advice and representation to support vulnerable and disadvantaged Victorian consumers. He is also the chairman of Consumers’ Federation of Australia, the peak body for the nation’s consumer organisations.


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July 2019
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