The federal government has announced [1] that a compensation scheme for victims of financial services misconduct will start from 2 April 2024, including a Compensation Scheme of Last Resort (CSLR) in the event that the financial service provider is unable to pay a compensation determination against it made by the Australian Financial Complaints Authority (AFCA). Only consumers and small businesses (as defined by AFCA – generally, under 100 employees) will be eligible to lodge a claim with a CSLR.
This regime follows the creation of AFCA in November 2018 as being central to the financial system external dispute resolution and complaints framework. [2] The Ramsay Report of September 2017 recommended a CSLR to support the operations and determinations of AFCA. [3]
Corporations Act Part 7.10B
The Corporations Act scheme, under – Part 7.10B – Financial Services Compensation Scheme of Last Resort, sections 1059 to 1069S – gives victims of financial services misconduct access to redress and compensation. They will be able to lodge claims for compensation under the CSLR with payments to follow for eligible consumers.
The CSLR will provide compensation of up to $150,000 to eligible consumers who have an unpaid determination from AFCA relating to the provision of personal financial advice, credit intermediation, securities dealing and credit provision.
AFCA must take appropriate steps to require the amount specified in its determination to be paid by the relevant entity.
One reason an AFCA determination may be unpaid is that the financial service provider has become insolvent. In such cases, on payment of the compensation to the victim, the CSLR will become an unsecured creditor in the insolvency. As such, it will be entitled to any dividend payable from the remaining assets of the adviser and will otherwise be entitled to information and to attend and vote at meetings of creditors.
The Corporations Act provides that if the entity is in insolvency (see definition of a ‘Chapter 5 body corporate’ in s 9), AFSA will “engage” with the liquidator or the administrator “to assess whether [it] will pay the amount …”: s 1064(2). The consumer may receive part of their compensation payment from any dividend in the company’s external administration: s 1067.
The CSLR then becomes subrogated to the rights of the consumer in the external administration for the amount of compensation paid: s 1069A. If the relevant AFCA determination exceeds the amount of compensation paid under the CSLR, the consumer retains their rights and remedies against the relevant entity for the excess.
FEG comparison
This is broadly similar to the right of the Fair Entitlements Guarantee Scheme to become a creditor on payment of an employee’s unpaid entitlements on the insolvency of their employer. That was a model referred to in the September 2017 Ramsay Report recommending the CSLR.[4]
The difference there is that FEG is entitled to the priority rights of employees given them under the Corporations Act, including their priority claim over circulating assets: ss 556, 560, 561. The CSLR would be like any unsecured creditor with no priority; but it could provide funding for legal recovery proceedings that may be required, for example to pursue assets unlawfully transferred by the company, and seek a priority under s 564 Corporations Act.
The Financial Claims Scheme under Division 2AA of the Banking Act 1959, whereby depositors’ losses are guaranteed by the government to a capped amount in the event of a bank failure, is a comparable example.
Moral Hazard?
An issue with any such scheme is that it could create a moral hazard in encouraging consumers to engage in riskier behaviour and become less diligent in checking a financial firm’s compliance history.
However the Ramsay Report saw this as being of “very small” risk for a number of reasons. AFCA cannot make awards to compensate consumers for investment losses, which means losses arising from higher risk investments would not be compensable by a CSLR; consumers are generally unable to assess a financial firm’s compliance history or identify which firms are more likely to become insolvent; the $150,000 compensation cap means that there is a limit on what a consumer or small business can recover from a CSLR; and for a consumer or small business to access a CSLR, they need to first suffer a loss and then spend considerable time going through the dispute resolution process, which involves uncertainty for them about whether they will be successful.
The CSLR is the last resort and final safety net to ensure consumers and small businesses are able to receive compensation but only after all other avenues have been exhausted.
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[1] Financial services misconduct compensation scheme to start from 2 April 2024 | Treasury Ministers This link contains more details.
[2] Commonwealth of Australia 2017, Review of the financial system external dispute resolution and complaints framework: Final Report.
[3] Review of the financial system external dispute resolution and complaints framework (treasury.gov.au)
[4] Review of the financial system external dispute resolution and complaints framework (treasury.gov.au)
