Doing it the Australian way, ‘twin peaks’and the pitfalls in between
by Dr. Andy Schmulow
The ‘Twin Peaks’ method of financial system regulation is widely regarded as the leading model for the regulation of a country’s financial system (https://www.academia.edu/20263128/The_four_methods_of_financial_system_regulation_An_international_comparative_survey). Australia was the first to adopt the model in 1997, has been using it the longest, and fared the best among the G20 during the global financial crisis. As a result, Australia’s Twin Peaks model is being exported around the globe.
The model was first proposed by an Englishman, Dr Michael Taylor, in 1994. So-called because it proposes two, specialist, mega-regulators: one charged with the maintenance of financial system stability (ensuring banks don’t end-up bankrupt), and the other with market conduct and consumer protection (ensuring banks don’t make their customers bankrupt). And yes, Taylor did have David Lynch’s mini-series in mind when, somewhat tongue in cheek, he named it ‘Twin Peaks’. In Australia, the system stability regulator takes the form of the Australian Prudential Regulation Authority (APRA), and the market conduct and consumer protection peak takes the form of the Australian Securities and Investments Commission (ASIC). Australia’s federal reserve, the Reserve Bank of Australia, has overlapping responsibility for financial system stability, and remains the lender of last resort. So in Australia’s case the ‘Twin Peaks’ moniker is a misnomer. It should more correctly be called ‘Three Peaks’. To date, other countries that have adopted the model include the UK, the Netherlands, New Zealand, Qatar and South Africa. Those that have signalled a desire to adopt it include South Korea, Hong Kong and the federal level of the Eurozone.
Much of what this model hinges on is the notion that each of the two peaks will best discharge their obligations if they are separate, mission focused, equal to, and independent of, one another. (http://www.cifr.edu.au/assets/document/WP053-2015%20Godwin%20E018%20Approaches%20to%20Financial%20System%20Regul.pdf). The contrary approach is to create one of the two peaks as a lead regulator. Twin Peaks rejects this approach because, correctly, it anticipates that if a lead regulator is created, it will far more likely be the system stability regulator, not the market conduct and consumer protection regulator. This is simply because a threat to the entire financial system would be regarded by policy-makers as more severe than a series of instances of consumer abuse or market misconduct. While there is much with which to sympathise with the view that the system stability peak’s job is more important than the market conduct and consumer protection peak, market conduct and consumer protection are nonetheless important enough that they ought not to be created weak, and then be allowed to decline in importance even further from then on. There is also the fact that market conduct and consumer abuse can potentially affect system stability. For example, the subprime disaster was market misconduct (fraud on an industrial scale, like that at Countrywide, and the design and sale of financial products designed to fail) and consumer abuse (reckless and predatory lending in the sub-prime industry) writ large. The subprime disaster then metastasised into an international financial system stability crisis – the global financial crisis – a firestorm that swept the globe, and whose embers glow still in many parts of the world, eight years later.
The need for two, equal and independent regulators extends to the need to keep the financial system regulator separate from the central bank – as is the case in Australia. As a result, in our advice (https://www.academia.edu/22374021/Submission_on_the_Financial_Sector_Regulation_Bill) to the South African Treasury in 2014/2015, on the first draft of their legislation adopting the Australian model, my colleague in the Melbourne Law School, Andrew Godwin, and I advised the South Africans not to establish their financial system stability regulator as a division of their central bank.
The model’s strengths are significant. It invests regulators with a clear remit, and greater certainty as to their jurisdiction than does a heavily bifurcated model with multiple regulators, one for each type of product, or one for each type of financial firm. As a result turf wars are less frequent and less corrosive. Among regulatees there is more certainty as to which regulator has authority over them in a given situation or in respect of a given product, and hence, less confusion. The same holds true for consumers who, instead of being confronted by an ‘alphabet soup’ of regulators, have certainty of where to seek assistance. Two mega-regulators are far less likely to emit conflicting and contradictory regulatory signals, whereas multiple regulators would. Similarly, opportunities for regulatory arbitrage are diminished, and regulators have the opportunity to build capacity and specialisation in their field, while pooling the resources and the human capital that would otherwise be spread over multiple agencies. Finally, two mega-regulators are able to present a united front to government and industry, alike.
For good reason then, the Twin Peaks model has received endorsements from the Basel Committee, the IMF, G20, World Bank and others. The question, however, is whether the Australian model, which is being emulated internationally, is transferable? Attributes that Australia possesses, and which are important contributors to the model’s success in Australia, may not be evident in other destinations. In Australia, inter-agency co-operation and collaboration (‘soft law’) are important contributors to the model’s success. As a result, the relationship between the three peaks in Australia has historically been closely co-operative, and not riven with rivalry and turf-wars. Furthermore, the functions of the three peaks have not been subjected to political interference, either. Moreover, Australian public servants are, on the whole, highly skilled and, largely, incorrupt. Disputes are pursued by a professional legal fraternity who, if need be, will seek adjudication before a fiercely independent judiciary, uncorrupted, and existing within a state based upon rule of law. By comparison, South Africa, the country that has most recently adopted the Australian model of Twin Peaks, either lacks some of these attributes, or if it has them, then they are not as strongly evident. Added to this, at the advent of the GFC, Australian banks were principally focused on their domestic market, they were not heavily exposed internationally, and had almost no exposure to the highly derived, opaque and esoteric derivatives market – CDOs – which would have exposed them to the US housing market. These are the reasons why Australia fared well during the GFC. Only one component, therefore, was the model by which the financial system was regulated. Future adopters of Twin Peaks, with banking systems more internationally inter-connected than that of Australia’s prior to the GFC may quite possibly, under the same crisis conditions, fare worse.
That was certainly the case with the Netherlands which, in 2002, became the second country to adopt Twin Peaks. The GFC proved catastrophic for the Dutch banking sector, with total foreign claims on Dutch banks amounting to 300 % of GDP. Yet if you look across the characteristics that explain Twin Peaks’ success in Australia, you see the same characteristics, strongly evident, in the Dutch state. All except for a ‘vanilla’ banking sector – by contrast with Australia, Dutch banks were heavily exposed internationally. One possible explanation, therefore, for the Dutch experience, is that while they had the optimal regulatory model, it was the investment profile and business model of Dutch banks that brought their banking sector asunder. The fact that Australian banks had a different investment profile and business model was not due to the use of Twin Peaks. It was good luck.
Added to the international failure of the model which occurred in the Netherlands, are the failures of Twin Peaks in Australia. These include the collapse in 2001 of a large and significant insurer – HIH – under APRA’s watch, and the near failure of Zurich Insurance Australia in 2000. Then there is the dismal performance of ASIC in the financial advice scandals that have rocked Australia continuously since 2014 – a performance excoriated (http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/ASIC/Final_Report/~/media/Committees/Senate/committee/economics_ctte/ASIC/Final_Report/report.pdf) by Australia’s Senate.
Put together and you see a model that has much to commend it, and is possessed of strengths both anecdotal and jurisprudential. But you also will observe a model that requires favourable conditions in which to operate optimally – much of which relate to ‘soft law’ – along with a banking industry that, of its own impetus, operates conservatively.
But, as stated, and even in countries possessed of most if not all of the characteristics necessary for success – Australia and the Netherlands – the model has demonstrated critical points of failure. Consequently, while Twin Peaks does have much to commend it, it is by no means a panacea for financial crises and contagion. It is simply one quiver in a bow.
To paraphrase Churchill, Twin Peaks is not the beginning of the end, it is merely the end of the beginning.
Dr Andy Schmulow has a BA Honours and an LLB from the University of the Witwatersrand, Johannesburg, and a PhD from the University of Melbourne. He is the Principal of Clarity Prudential Regulatory Consulting Pty Ltd, an Advocate of the High Court of South Africa, a Visiting Researcher in the Oliver Schreiner School of Law at the University of the Witwatersrand, and a Visiting Researcher in the Centre for International Trade at Sungkyunkwan University in Seoul. He is shortly to assume a role as a Senior Lecturer in the Law Faculty of the University of Western Australia in Perth. He may be reached on