Australia’s Twin Peaks regulatory model optimal for financial stability – CIFR

by Dr. Andy Schmulow

10 February 2015 (Sydney): The Centre for International Finance and Regulation (CIFR) has released extensive research on financial system regulation which shows the Twin Peaks model is the ideal method for financial stability. The Twin Peaks model employed by Australia and, more recently, the UK separates oversight of financial stability and market conduct. The research credits the model with helping Australia successfully navigate the worst of the global financial crisis but warns that having the optimal regulatory model is just a start when it comes to avoiding crisis and market abuse.

The research has served as an important input to draft legislation in South Africa as the country looks to emulate Australia’s Twin Peaks model in its most significant financial regulation reform in a generation. Currently in vogue internationally, the Twin Peaks model is regarded as the most effective of the four methods of maintaining financial system stability.

The researchers behind the CIFR-funded project, Andrew Godwin and Dr Andrew Schmulow from The University of Melbourne, found that there were several pre-requisites for the effective operation of the Twin Peaks model. These include a clear allocation of objectives and responsibilities between each regulator; effective co-ordination; transparency and accountability; effective powers of supervision and enforcement; operational independence (vis-à-vis the executive government); a sound governance system and adequate resources.

The research indicated that even with all of these criteria in place, a Twin Peaks regulatory system cannot guarantee against financial crises or even financial distress. Neither can the model guarantee against financial firms engaging in market misconduct or consumer abuse, as evidenced by the findings of the Senate Inquiry into the performance of the Australian Securities and Investments Commission last year.

Dr Schmulow said, “What Twin Peaks does offer is a good start, by imposing what the evidence strongly suggests is the best and most optimal regulatory architecture. From there, the avoidance of financial crises and market abuse will depend upon the culture and leadership of the two peaks, and their willingness to tackle difficult questions and powerful vested interests. That in turn is in large measure dependent upon the extent to which political leaders are insulated from industry pressure, and the extent to which the government will adequately fund and resource the regulators. To paraphrase Churchill, Twin Peaks is not the beginning of the end. It is merely the end of the beginning.”

The researchers made 25 specific recommendations for South Africa’s regulatory model based on the experience in Australia and the challenges this model presents. Twenty two of these recommendations have been incorporated into the draft South African legislation, demonstrating high regard for Australia’s regulatory regime.

Chief among these was the importance of a ‘culture of co-ordination’ under which the main focus is on regulatory performance rather than regulatory structure. In this regard, the high-level, outcomes-focused and ‘soft law’ approach adopted in Australia offers an interesting contrast to the more prescriptive ‘hard law’ approach in the United Kingdom, and the proposed approach in South Africa. Of critical importance, is achieving an appropriate balance between formality and flexibility; namely, making clear provision for the nature and scope of regulatory co-ordination while at the same time ensuring that the system is sufficiently flexible to allow it to adapt to specific circumstances, as and when they arise.

For interviews with the researchers
Heather Gascoigne, The Continuum Partners
+61 410 297 111.