COMMONWEALTH OF AUSTRALIA Official Committee Hansard

SENATE

ECONOMICS LEGISLATION COMMITTEE

ESTIMATES

(Additional Estimates)

THURSDAY, 19 FEBRUARY 2004

CANBERRA

BY AUTHORITY OF THE SENATE

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Thursday, 19 February 2004 Senate—Legislation E 1

SENATE ECONOMICS LEGISLATION COMMITTEE Thursday, 19 February 2004

Members: Senator Brandis (Chair), Senator Jacinta Collins (Deputy Chair), Senators Chapman, Murray, Watson and Webber Senators in attendance: Senators Allison, Brandis, Chapman, Conroy, Kirk, Lundy, Mackay, Mason, Murphy, Stephens and Watson

Committee met at 8.39 a.m. TREASURY PORTFOLIO Consideration resumed from 18 February 2004 In Attendance Senator Coonan, Minister for Revenue and Assistant Treasurer Treasury portfolio Mr Mark Rodrigues Mr James Bond Mr Gareth Perry Mr Steve French Mr Chris Legg Mr Peter McCray Mr Jim Murphy Mr Mike Rawstron Dr David Gruen Dr Jim Hagan Dr Steven Kennedy Dr Martin Parkinson Dr Heather Smith Ms Bernadette Welch Australian Accounting Standards Board Mr David Boymal, Chairman Mr Angus Thomson, Technical Director Australian Competition and Consumer Commission (ACCC) Mr Robert Antich, General Manager, Compliance Strategies Branch Mr John Bridge, Chief Finance Officer Mr Brian Cassidy, Chief Executive Officer Mr Joe Dimasi, Executive General Manager, Regulatory Affairs Division Mr Tim Grimwade, General Manager, Adjudication Branch Ms Lee Hollis, General Manager, Enforcement Co-ordination Branch Ms Helen Lu, General Manager, Corporate Management Branch

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Mr Mark Pearson, General Manager, Mergers and Asset Sales Branch Mr Nigel Ridgway, Deputy General Manager, Compliance Strategies Mr Graeme Samuel, Chairman Mr David Smith, Executive General Manager, Compliance Division Ursula Everett, Adjudication Branch Australian Prudential Regulation Authority (APRA) Mr Ross Jones, Deputy Chairman Mr Tom Karp, Executive General Manager, Diversified Institutions Mr Brandon Khoo, Executive General Manager, Specialised Institutions Dr John Laker, Chairman Mr Charles Littrell, Executive General Manager, Policy, Research and Consulting Dr Darryl Roberts, General Manager, Rehabilitation and Enforcement Mr Stephen Somogyi, Member Australian Securities and Investments Commission (ASIC) Professor Berna Collier, Commissioner Mr Carlos Inglesias, Executive Director, Infrastructure Mr Ian Johnston, Executive Director, Financial Services Regulation Mr Peter Kell, Executive Director, Consumer Protection Mr Jeffrey Lucy, Acting Chairman Ms Pam McAlister, Director, FSR Legal and Technical Mr Greg Pound, Chief Accountant Ms Jan Redfern, Executive Director, Enforcement Mr Malcolm Rodgers, Executive Director, Policy and Markets Regulation Ms Pauline Vamos, Director, FSR Licensing Australian Taxation Office (ATO) Mr Michael Carmody, Commissioner of Taxation Mr Paul Duffus, First Assistant Commissioner Ms Lesley East, Assistant Deputy Commissioner Mr Greg Farr, Second Commissioner Mr Kevin Fitzpatrick, First Assistant Commissioner Ms Erin Holland, Deputy Commissioner Mr Mark Jackson, Deputy Commissioner Mr Mark Konza, Deputy Commissioner Ms Alison Lendon, Deputy Commissioner Mr Michael McDermott, Assistant Deputy Commissioner Mr Neil Mann, Deputy Commissioner Ms Donna Moody, Chief Finance Officer Mr Gregory Topping, Assistant Deputy Commissioner Ms Raelene Vivian, Deputy Commissioner Inspector-General of Taxation Mr David Vos, Inspector-General Mr Steve Chapman, Deputy Inspector-General National Competition Council (NCC) Mr John Feil, Chairman

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Ms Michelle Groves, Director Mr Ross Campbell Mr Alan Johnston Productivity Commission Mr Robert Kerr Mr Garth Pitkethly ACTING CHAIR (Senator Watson)—I declare open this public hearing of the Senate Legislation Committee. I would like to take this opportunity of welcoming back Mr David Boymal. I presume, Mr Boymal, you have been advised of the rules and protection offered through parliamentary privilege in relation to what you say. Mr Boymal—Yes. ACTING CHAIR—I thank you for assisting the committee by coming back this morning. We apologise for any inconvenience it may have caused. Would you like to comment on any matters that were raised yesterday? Mr Boymal—No. ACTING CHAIR—Then we will proceed to questions. Senator CONROY—We were talking about what is now AASB 1046. We had been talking about excess value last night. I want to move on to a slightly different strand. Under that standard, benefits in the form of equity in an entity other than the disclosing entity or its subsidiaries—for example, an overseas-listed parent company—is not classified as an equity compensation scheme. Does this mean that such benefits do not need to be disclosed? Mr Boymal—I will pass the question to Mr Thomson. Mr Thomson—Could I clarify that? If you had an Australian company with an overseas parent, the management in Australia may be remunerated in part with equity from the overseas parent, perhaps because the local company may not be listed and therefore there is no equity available in that entity. Where that happens, it would be normal practice for the Australian legal entity to pay in some way for that equity. So there should actually be a cash amount or a payable representing that equity compensation. So it is not that it would go unrecorded— Senator CONROY—Even if it is an option? Mr Thomson—Presumably— Senator CONROY—Let us say it is a US company and they have not quite adopted expensing, because there is still a lively debate over there—so there is no value to be attributed to it in the US, because they do not. Therefore it is an option to be issued in a US company. Mr Thomson—I understand that they may not attribute any value under their accounting standards, but the commercial reality would be that they have given away something of value. Senator CONROY—I am with you 100 per cent, but the issue is why we do not capture it as part of their remuneration. This is not just about the accounting treatment; it is also about ensuring disclosure to shareholders in that company here.

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Mr Boymal—Could I explain? It is quite correct when you say that it is not required to be expensed in the United States. But it is also not required to be expensed in Australia. However, in the United States, that there is value in the option has been recognised or acknowledged for a long time. That is why in the United States reporting, notwithstanding that it is not expensed, the values to be attributed to the options are disclosed. Therefore it is not correct to say that because they do not expense it they are not acknowledging there is a value in it. Actually, more so in the United States than here, because their rules have been around for much longer, they would acknowledge that there is a value to it. Senator CONROY—The angle I am coming at this from is that of wanting to make sure that remuneration is disclosed to Australian shareholders and the Australian market so that people can make a judgment about these things. I am keen to make sure you are confident that you will be capturing any remuneration in shares other than the disclosing entity or its subsidiaries. Mr Boymal—No. I think you have a point that, if a company was trying to deliberately circumvent and was in the situation of having an overseas parent, they could deliberately circumvent by simply avoiding the parent company putting a charge through to the subsidiary. Therefore, if that were the case—and there would be no way to stop that from happening— then it would not be disclosed in the cash remuneration, nor would it be disclosed in the issuance of options. Senator CONROY—I am in danger of getting my wife in trouble here. My wife works for a company—not that she is in senior management—that is basically an American company that has listed here simply for the purposes of the employee share scheme, otherwise it would not bother listing here. Say, for instance, if Goldman Sachs wanted to issue shares in Goldman Sachs in the US to the managing director of Goldman Sachs here in Australia without doing that, how will we deal with this as an issue? It is not as though it necessarily has to be completely deliberate. For the purposes of disclosure to the Australian markets to know what the executive is being remunerated, is there a way we can capture it? Is this is a simple one to think about and tweak a bit or is this one that moves into a completely different area that is simply too hard to handle? What is the rationale behind leaving these schemes out? Mr Boymal—There are probably jurisdictional difficulties. In the first instance, the number of instances where the Australian public shareholders would be interested are very limited, because most of the overseas-owned companies are 100 per cent owned and therefore it is not typical that the public would be interested. But there are a few like that. Where the Australian subsidiary and the overseas parent are both listed and therefore the public is differentially interested in both, the AASB takes the view that the directors would in fact have to be breaching their governance responsibilities by one of the companies bearing and therefore hiding a charge that is properly attributed to the other company. So you have a combination of very few instances in the first place— Senator CONROY—You have never heard of transfer pricing? Mr Boymal—Yes, I have heard of it. Senator CONROY—This is an equivalent, almost—a transfer share option.

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Mr Boymal—Only in a situation, though, where public shareholders are interested in the Australian subsidiary. Whereas transfer pricing applies primarily to wholly-owned companies, not partly-owned companies. Senator CONROY—Sure. But what shareholders are interested in is, when the managing director of the local, say, Goldman Sachs comes before Australian shareholders and says, ‘My remuneration needs a bit of an increase or some local shares,’ they are not able to look at his total package and make a judgment, because somewhere else there are some shares that have been issued in the parent company. The key here is—even though it may be a cost of value over in the US and therefore the parent company has taken a hit—whether shareholders in Australia in the subsidiary are able to make an informed decision about the claim by the boss that he is underpaid and needs a pay rise or whether it is a justified pay rise. They are not fully informed. They are not given all the relevant information by our standard. Mr Boymal—There remains a risk of that. Instances will be few and far between. It would have involved a breach of corporate governance between the two companies. But, if those companies set out to mislead, it would be possible for it to happen. The idea of expensing these options and shares is on the verge of being adopted in Australia and the United States. That in itself would remedy the point that you are making in addition. Senator CONROY—Sure. When you say ‘set out to mislead’—you are not a lawyer and I am not a lawyer, thank God— Senator Coonan—You keep saying that, Senator Conroy. Senator CONROY—You should try working in my office and being a lawyer—it is just a misery. The issue is that lawyers do not look at it on the basis of ‘set out to mislead’; they would just ask: ‘Is it legal?’ And, if they say it is legal, they are not setting out to mislead; they are complying with the law. If the law allows a loophole for a smart lawyer to say, ‘It’s legal,’ then what you and I view is fundamentally a deliberate attempt to mislead—and I agree with your interpretation entirely—a lawyer would say, ‘Tough. It’s legal.’ I am interested and maybe some further discussions can— Mr Boymal—The point you make is valid. There would be jurisdictional difficulties in obtaining the information. Historically, there has been a requirement to disclose if, for example, the salary of the chief executive is paid by the overseas parent. There have been awful troubles in obtaining that information because of jurisdictional difficulties. It could have been put into the standard, but that is not to say that the information still would have been forthcoming. By the time these things that we are talking about are expensed, the total picture is that it is covered. Senator CONROY—We might follow up with some discussions about that down the track, but thank you for that. Disclosure of loans is required where they exceed $100,000. Why $100,000? What was the basis of the $100,000? I know you have to pick a figure but why was it $100,000? Mr Boymal—I believe it was really nothing more than a value judgment in terms of what is regarded as significant and therefore of interest, and what may not be. I guess that whenever one picks an arbitrary line of that nature then one could ask that question. It was purely a value judgment in terms of what was considered to be reasonable.

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Senator CONROY—Does the loan have to be in dollar terms? I am thinking of non- recourse loans. There is a guarantee to make sure you do not have to pay a non-recourse loan. Do they fall into this capture? Mr Boymal—All loans would, irrespective of what the terms are. Senator CONROY—Yes, but there is a dollar value. In a non-recourse loan there is not necessarily a dollar value possible to be prescribed, because you do not know about the movements in the market. Genuinely, I am not sure how you would value that. You might be able to make an estimate. If a share price is here today and the non-recourse loan says it is here, but you end up having to do it here, therefore the downside is being paid for by the company. So there is— Mr Boymal—I understand. Senator CONROY—I am glad you understand, because I know I have not explained it very well. Mr Boymal—I am an ex-auditor, so I understand that point. Our view is that—irrespective of whether it is a non-recourse loan and the actual amount might, at any point in time, be payable—it is limited by the underlying value of the shares. Nonetheless, there is a loan amount of a stated figure, and I would believe that it would be correct— Senator CONROY—So the non-recourse element would not be captured? Mr Boymal—Indeed. The actual contracted amount that is identified would be the amount that would be shown. I say that because the non-recourse aspect normally only applies at the point of departure of the person from the employ of the company and at what the share price may be at that future point in time. It is basically: ‘I owe the money but I do not have to pay it.’ But the fact that it is owed is still a fact. I do not think it could be argued that it would be appropriate to show a lesser amount than the full amount of the loan. Senator CONROY—Say it is $101,000—I am not arguing that they would not disclose $101,000. My concern is that the real value of the loan is more than $100,000. What I am actually worried about is someone saying, ‘We’ll give you a $50,000 loan, but it will be non- recourse,’ and the non-recourse is set in such a way that you are almost certainly going to end up where the company picks up the non-recourse bit. So you can disguise the size of the loan to keep it below the $100,000 limit so it is not disclosed. I hope you are still with me. Mr Boymal—I am with you. I think it would actually work the other way. The full, upper amount of the loan is the amount that would need to be disclosed. If the terms were such that, if perchance something happens, it may be a lower amount, that would be explained in the description of the terms of the loan, but it would not be a justification for showing it at a lower amount. Senator CONROY—This is on a similar issue. Amounts to be paid in the period after an individual has resigned are accrued and disclosed in the period in which the individual earned the right to be paid, so it is not included in subsequent reporting periods. The issue is the difference between how much will be disclosed and how much is actually paid. A concern which has been raised by the Shareholders Association in relation to the standard is that companies do not have to disclose the market value of vested shares and options or the value

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 7 of unvested options. Is it the AASB’s view that the shareholder can work it out for themselves by reviewing old annual reports? From a shareholder’s perspective—bearing in mind that financial reports are about reporting to shareholders—a worksheet would be useful. Mr Boymal—I will hand this to Mr Thomson, because I believe he answered a question very similar to that one last night in relation to— Senator CONROY—Mandatory reporting and things like that? Mr Boymal—No, as to whether the appropriate date is the granting date or the vesting date. I think the answer is in fact very similar. Mr Thomson—Indeed it is roughly the same theme as we were on last night—that, having made a judgment that we measure the thing at grant date, you then do not worry about following it up later and finding out how much people finally made out of it, because, once they have got that thing against their name as having been granted to them, that is their remuneration. After that, it is really what happens to the markets, once they have vested and exercised it, how the price went and how they managed to make money out of that themselves. Senator CONROY—I say yes and no to that. What is at issue here is that shareholders want to make sure their executives are getting fair pay. If they have vested them at one price and then share prices have gone up—and that is a good thing; everyone is happy—the issue, if you follow me, then becomes: ‘Well, they have made all this money, so they do not necessarily need to put forward as big a claim next time.’ If the shares have taken off—we gave them $200,000 worth of shares last time but they are actually picking up $400,000 now—they do not need to come back and say, ‘We need another big swag of shares.’ So it is really about keeping shareholders informed about what has actually happened to the remuneration and the components of the remuneration. Mr Boymal—Philosophically, the AASB has adopted the view that the measure of the remuneration is the value of this item at the point that it is granted. What happens to the value after that is not to do with remuneration. There may be some curiosity value—I think I used that term last night—in what happened afterwards, but it is not the measure of remuneration. Let me give a different example. If the total remuneration were in cash, let us say, and the executive then bought some shares in the company and two years later those shares have skyrocketed up, is it a measure of the remuneration that this person has scored very well from having acquired those shares? I think the answer is no; the fact that that person has scored well is private business, and the remuneration is what the measure was at the date that he was granted the cash remuneration, as it is in this case. We follow that philosophy through. There is some information about what happens subsequently, but that information is shown in what the total holding of that individual is. So the total holdings of options and of shares—opening balance, movements for the year, what the reason for the movements was, and closing balance—is disclosed. But dollars are not attributed to that—it is the number of shares and options—because the way the dollar value moved after the granting is regarded as a private matter. You may say it is the good fortune— but it may be the bad fortune too—privately of the individual. That is a philosophical approach to it.

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Senator CONROY—Thanks. The other concern I have about the standard is that disclosure of an equity value protection scheme is not required. In my view, shareholders are entitled to know if their directors or executives are insulating themselves from risk in this way. The whole point of the equity components of packages is about aligning interests. These sorts of packages sever that link. While I would prefer it if they were voluntarily disclosed now, it is clear that they are not being voluntarily disclosed and shareholders are grumpy when they find out that they come to you one day and say, ‘We want to align ourselves with your interests,’ and yet behind the scenes they have deliberately severed the link. Disclosure has failed so far, which is why they have proliferated. I am sure that, once shareholders work out that they are being dudded in this way, there is going to be a bit of an argument. The issue is just putting it out on the table. If people want to have these things, then they can argue with the shareholders that they are reasonable. But there is a role for mandating some things. We are not banning anything; we are just mandating disclosure. I have a great deal of difficulty when we do not mandate disclosure. I was just wondering why you said no to that. Mr Thomson—I think you are referring to where, for example— Senator CONROY—It is a hedging instrument. Mr Thomson—yes—someone has been granted an instrument and, if they perform well, it will vest but, some time between grant and vesting, they may take out another instrument which locks in the value of the instrument that is being granted to them and so they are no longer dependent on the performance indicators. Senator CONROY—That is not philosophical. This is about disclosure to shareholders and it is about whether shareholders are informed that the very reason the equity package has been put on the table in the first place has actually been subverted by management. Mr Boymal—We would have thought that that would be covered by the general requirement to disclose the terms. Senator CONROY—No. CLERP 9 unfortunately does not cover it either. Mr Boymal—I appreciate the point that you have made, which is that the terms may be clear-cut at the point that the grant occurred, and this additional instrument that hedges it may happen afterwards and therefore it is not disclosed within the original terms. I think that if you read broadly the requirement to disclose the terms you could argue that all of these things are covered by that, but if you read the requirement to disclose the terms narrowly I suppose you could rationalise your way out of it. Senator CONROY—I think you were witness last night to a conversation about how narrow lawyers can be when they want to be, Mr Boymal. This is one of those occasions when you suddenly get the most narrow possible definition being championed from the rooftops. Mr Boymal—Yes. Mind you, the standard is out, but I think we should take that piece of advice on board. Senator CONROY—Thanks. Clause 5.2.15 of the standard says that, in relation to employee share plans, if there is no link between services provided and participation in the

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 9 scheme, then the scheme is non-compensatory. Does this mean that disclosure is not required in this instance? Mr Thomson—Not as remuneration, no. Senator CONROY—How do we capture it for disclosure? What else would drag it in so that it is on the table? Mr Thomson—As Mr Boymal indicated earlier, the numbers of instruments held by directors and specified executives are required to be disclosed. It would appear in those numbers. But if something is not remuneration we would not call it remuneration. If something does not fit the definition of remuneration, we would not classify it as remuneration. Senator CONROY—You see, that is what lawyers are good at. They are good at saying, ‘That’s not really remuneration.’ Mr Boymal—No, but it still will appear, which I think is your principal point. Senator CONROY—But remuneration is going to be revealed at one point and then maybe somewhere else—on page 77, the third footnote down—you might find there is another number; or it might be in some table that does not appear to be related. They are very clever at hiding these things. Mr Boymal—Yes, but I think we should get straight that there are two principal factors of disclosure relating to the interests of directors and the top executives. One is the remuneration aspect: is this part of your pay? The other relates to what the holdings are. The holdings could be bought on the market. The total holdings can be quite different from the remuneration, but the remuneration is a piece of the total holdings. We have gone further than they have gone in the United States because we have not just asked for disclosure of the total holdings at the end of the year, which is what they call for in the United States. We are asking for a reconciliation of the movement of the holdings from the beginning of the year to the end of the year. It will go something like this: held so much at the beginning, received so much for remuneration, bought so many on the open market, sold so many and —your new point— were given an additional slice. There is a requirement to disclose that there is something more that has been issued and not paid for that is not in remuneration. By virtue of us calling for that disclosure, it would show up like the proverbial. If something is being given that is not being called remuneration, we are asking for that to be shown. Yes, they did not call it remuneration, but the fact that they found a way not to call it remuneration would show up clearly. I think we have got that one covered. Senator CONROY—I do not want you to miss your plane, so unless you want to add something, Mr Thomson, I was going to let you go. Mr Thomson—Perhaps I could deal with this very quickly: did you refer to 5.2.12? Senator CONROY—No, it was 5.2.15. I will put my questions on notice, thank you very much.

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[9.12 a.m.] Australian Prudential Regulation Authority CHAIR—I welcome to the table Dr Laker, the chairman, and officers of the Australian Prudential Regulation Authority. Dr Laker, do you wish to make an opening statement? Dr Laker—Yes, I would like to make an opening statement. I will try to keep it brief. Last November, the new APRA executive group, on its own, appeared before this committee for the first time. Today we are here with the full management team of APRA to respond to any questions the committee may have. Since we last met, there has been valuable progress to report on two major supervisory initiatives. The first concerns the prudential framework for general insurance. In November, we released a discussion paper seeking public comments on a proposed second round of general insurance reforms. The paper outlines the proposal to revise the existing prudential standards and guidance notes, covering things such as corporate governance amongst others. It also outlines proposals to increase disclosure about the activities of general insurers in order to promote market discipline. The responses to this discussion paper have been generally positive. Corporate governance issues always provoke a lively debate, but our meetings with interested parties to date have been constructive. The period for submissions closes shortly and we will have further consultations before the reforms are finalised. The second supervisory initiative—it is very familiar to this committee—is the prudential framework for superannuation. The Superannuation Safety Amendment Bill 2003 is now before the parliament. It is currently the subject of an inquiry by this committee. APRA has made a submission focusing on its role in implementing the proposed superannuation licensing regime, and APRA’s staff appeared before the committee last week. We are currently preparing guidelines on the proposed regulations and operating standards for trustees which we will put out for public consultation shortly. Our intention is that all explanatory material relevant to the licensing process will be available before the licensing period begins. Trustees will know exactly what is expected of them, and there will be no advantage to trustees who delay applying in the expectation that the process will change. Over the past few months APRA has been conducting a major exercise to track down superannuation funds which have not been lodging annual returns. About a year ago, we had identified about 2,000 such entities. We have found that around 1,100 of these have become compliant with the superannuation legislation or are subject to action to ensure compliance. A further 600 had either never existed or had wound up without informing APRA. That left around 400 funds which have been untraceable. In January we disqualified the last known trustees of these funds and appointed an acting trustee. A scheme—announced yesterday—has now been put into place to wind up and dissolve these untraceable funds. The effect is that, in the unlikely event that any of these funds have material assets or membership, such funds will vest any assets back to the original members. The wind-up removes the legal capacity of these funds to continue to operate and claim tax concessions. When we met in November, I outlined what APRA had been doing to monitor the housing market exposures of authorised deposit-taking institutions—what I will call ADIs. I summarised the results of a stress test that we had conducted and confirmed that the results of

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 11 that test were reassuring but, as I emphasised then, no basis for complacency. We have been working with a small minority of ADIs which have been identified as needing to strengthen their risk management systems for housing lending. We are also reviewing lenders’ mortgage insurance arrangements between ADIs and their insurers. APRA is also tightening the prudential framework that applies to housing lending by ADIs. In November, we released proposals that loans where ADIs do not verify the borrower’s servicing ability, such as so-called ‘low doc’ loans, would require higher equity contribution by the borrower before such loans qualify for the concessional risk rate on housing lending for capital adequacy purposes. We are currently reviewing a number of submissions on these proposals. In December, after public consultation, we revised the capital adequacy standard for ADIs by requiring them to treat certain types of capitalised expenses—such as loan origination fees and commissions paid to mortgage originators and brokers—as intangible assets for prudential purposes and to deduct them from capital. The revised standard strengthens the capital adequacy framework for ADIs by enhancing confidence that assets are available to protect depositors should an ADI come under stress. Within the ADI sector the issue that has of course attracted most attention recently is the unauthorised foreign currency trading by dealing staff of the National Australia Bank. I would like to make some comments about that. On 13 January, the NAB announced that it had identified losses relating to unauthorised trading in foreign currency options. Following a market revaluation of their foreign currency options portfolio, NAB later announced that the pre-tax losses arising from this trading were $A360 million. NAB has acknowledged that there was a breach of its risk management systems and controls for options trading. This is being investigated by PricewaterhouseCoopers on behalf of NAB and, separately, by APRA. The Australian Securities and Investments Commission and the Australian Federal Police are also pursuing inquiries under their respective responsibilities. APRA is working with these agencies to ensure that the various lines of inquiry are coordinated. APRA’s investigation is focusing on analysing the trading activity that led to the losses, identifying the weaknesses in NAB’s risk management systems that allowed the unauthorised trades to occur, identifying responsibilities for the breakdown in internal risk oversight and reporting on what NAB needs to do to rectify the situation. APRA’s report to the three members of our executive group, which will also be presented to the NAB board, will be blunt and thorough, and APRA will follow through vigorously on the remedial program. We have put a highly experienced team on to this investigation. The team of six is led by an APRA general manager with around 18 years of experience in bank supervision. It includes APRA’s head of balance sheet and market risk, who has over 20 years of financial markets experience. The other team members bring a mix of treasury risk management skills and bank supervision experience. I provide this detail to illustrate a point I made to the committee in November—that APRA is building up its supervisory resources and skills, and now brings more weight and industry understanding to the table. Apart from this, I do not believe it is appropriate for me to talk specifically about our dealings with NAB. The committee will appreciate that APRA staff face strict secrecy obligations, and many aspects of this matter are commercial-in-confidence. However, the

ECONOMICS E 12 Senate—Legislation Thursday, 19 February 2004 committee might find it helpful if I were to explain in general terms how banks with significant treasury operations are expected to manage their market risks and how APRA goes about supervising these operations. Doing so will also enable me to correct a basic misconception which we still hear in some quarters: that any breakdown in any part of the risk management systems of a regulated entity must somehow be down to APRA. It is not. The fundamental premise of prudential supervision in Australia, as in any market economy, is that the prime responsibility for the prudent management and financial soundness of a regulated entity rests with the management and board of that identity. There would be no challenge from the board and management of NAB on this point. Banks with significant treasury operations trade in the full range of financial instruments in order to manage and diversify their risks, provide hedging and other services to their customers and manage liquidity in the relevant markets. Banks in Australia have been trading foreign currency options since the mid-1980s as part of a suite of financial products. By the end of December 2003, banks had outstanding written foreign exchange options positions of around $A270 billion. These face value amounts seem enormously large and, of course, complex financial instruments do involve risks. For Australian banks, however, the risk of losses from holding and trading these instruments is only a small fraction of their face value. Banks use sophisticated statistical modelling to assess the risks in their treasury operations and the amount of capital to hold against these risks. Estimates of risks are generated from historical market data, and the accuracy of these estimates is tested against actual experience and is stress tested against a range of adverse scenarios. Banks using these advanced models to calculate the risks for regulatory capital purposes must demonstrate to APRA’s satisfaction that the models are robust and the risks are prudently managed. For the four major banks, for example, APRA’s total capital requirements for market risk averaged around $A600 million over 2003—a large amount in absolute terms. However, it is only one per cent of the total capital held by these banks and only about 5 per cent of annual profits. As I said, face values give little guide to the risks in treasury operations. Risk management in the treasury area, as in any other significant business area, is the process of identifying, assessing, managing and reporting all risks that may have a material impact on the institution. This process starts at the top. It is the board that determines the institution’s tolerance for risk, approves its risk management strategies and policies and ensures that senior management is monitoring the effectiveness of risk controls. It is the audit or risk committee of the board that needs to assure itself that all risks are identified and appropriate risk management systems are in place and that—on an ongoing basis—the monitoring and audit process does not raise any material issues or weaknesses. It is senior management which implements the strategies and policies approved by the board and establishes the detailed risk management framework. In a prudently managed treasury operation, the main elements of this framework—I will only give you a brief summary—should include: detailed policies and procedures for trading each type of instrument; clearly defined duties and delegations for individual staff; limits on the type and scale of each type of trading; processes for monitoring compliance with the limits; procedures to verify and reconcile transactions; and, very importantly, adequate segregation of duties between traders—those who are called the front office, those responsible

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 13 for monitoring trading operations and risk limits, who are called the middle office, and those who independently confirm and reconcile the trades, who are called the back office. The internal audit function within the institution also plays a critical role in reviewing and testing internal controls and risk management systems. External auditors are also involved in assessing the risk management framework. Let me now turn to APRA’s role as prudential supervisor. As a general point, APRA seeks to assure itself that each supervised financial institution has appropriate risk management systems in place for the size, the business mix and the complexity of its operations. In evaluating banks with significant treasury operations, APRA focuses on the governance processes in place to manage risks. We do not sit at each trading desk monitoring trades to ensure limits are not breached or losses do not occur. That is not, and has never been in Australia, the role of the prudential regulator. Rather, we review the bank’s risk management policy, the skills and experience of managers, the reporting structures, management information systems and compliance controls. We expect banks with significant treasury operations to be following approaches which are close to or at best practice. APRA conducts on-site visits to these institutions by front-line supervisors and specialist market risk teams on a regular cycle. These visits generally run for up to a week and involve an assessment of risk management policies and procedures. We also look closely at the reports prepared by internal and external auditors, especially if they identify failures in compliance. We expect these reports to be provided to the audit or risk committee of the board and that there be an immediate response on material issues. Where APRA has its concerns we bring them to the attention of a bank’s senior management and board. We require a prompt response, and we follow up to ensure that appropriate action is being taken. Risk management systems, certainly in treasury operations, are complex and constantly evolving systems in which human behaviour can add an unpredictable element. These systems can break down and losses can arise as a result. No financial institution or prudential regulator can guarantee that that will not be the case. This is why the prudential framework in Australia, at its core, is aimed at ensuring that financial institutions diversify their risks across a range of operations and businesses and that they hold substantial capital resources as a buffer to cope with shocks. In this way, a single event or a breakdown of risk management systems in a particular area cannot break the bank, so to speak. A diversified, well-capitalised institution has the wherewithal to survive such breakdowns, rectify the problems and continue trading without putting at risk its obligations to depositors. The recent events at NAB need to be seen in this context. The losses arising from the unauthorised foreign currency trading are substantial on any absolute scale. Nonetheless, the losses did not threaten the financial viability of NAB—they represent less than two per cent of NAB’s regulatory capital—nor did they threaten the interests of its depositors. It is this group of beneficiaries that APRA is charged with protecting. CHAIR—Dr Laker, on that last point I am struggling to see why that is so relevant. Surely the magnitude of the loss, although in many dimensions obviously a relevant matter, is not so important from the point of view of the discharge of your statutory functions as the governance issues revealed by the fact that the conduct occurred. In other words, it does not sound to me to be very satisfactory for a regulator to say, ‘In mitigation it wasn’t, as a

ECONOMICS E 14 Senate—Legislation Thursday, 19 February 2004 percentage of the total capital held by the bank, such a big percentage.’ That seems to me, with respect, to address the wrong issue. Dr Laker—I do not offer that as mitigation. I simply offer that as the context of our prudential regulation, which is to ensure fundamentally that banks are well diversified and well capitalised. If we were not able to achieve that, those absolute amounts threaten the institutions. But to get to your point, yes, we are looking at governance issues. This is a governance question— CHAIR—Yes, that is what I thought. Dr Laker—for the NAB senior management and NAB board, and that is why several inquiries are under way at the moment. My point to the committee though—and it is one that I want to emphasise—is that it is the responsibility of the NAB board and the NAB management to address this breakdown in controls. They have accepted that point. We have seen the departure of the chairman, who acknowledged that it was his ultimate responsibility for the reputation of the institution. We have seen the departure of the previous chief executive. I want to emphasise that that is the starting point. Senator CONROY—Do you think that is enough? Dr Laker—I think it is important that we see the results of the inquiry before I could offer a comment on that. Senator CONROY—If you were chair of the audit committee you would have to be looking over your shoulder right now, wouldn’t you? Dr Laker—I do not want to prejudge the outcome of the inquiry or prejudice the inquiry at all. It is a very thorough inquiry on our part, which will look at the role of all of those internal checks and balances to make sure that that particular problem is rectified and will not occur again. Senator CONROY—They have appointed a member of the audit committee to take over as chair. Dr Laker—He was previously chair of the newly formed risk committee, yes. Senator CONROY—But he was also a longstanding member of the audit committee. Dr Laker—Yes. There will not be any part of the operation of the NAB in this area that we will not be looking at in the inquiry. Senator CONROY—Will you be making the results of your investigation public? I appreciate that you have some secrecy provisions, but would NAB have to give you permission to release it? Dr Laker—It is unprecedented, in my knowledge, that APRA has ever released the results of an internal investigation. Clearly, we are subject to secrecy requirements, in a sense, on behalf of any regulated entity. So there is a trade-off that I need to be careful about between respecting my obligations under the law and explaining to the Australian community what it is that APRA has been doing. I can quite frankly say that APRA has been on this case, and I am happy to put that forward in the appropriate circumstances. I need to balance that. I would like

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 15 a way of explaining to the community what it is that we have been doing, and what it is that NAB has done to rectify the problem. I think that provides an assurance. Senator CONROY—That would be a really important thing for you to do. Dr Laker—I agree, but I think the community needs to know that we have been on the case. I would like to see the report, and I would like to see how the PricewaterhouseCoopers report is handled as well before I offer a considered judgment at this point. Senator CONROY—But NAB could release your report if they wanted to? Dr Laker—Yes, it is my understanding that they could if they wanted to. Senator CONROY—Do you need their permission to release your report? I am just trying to clarify the factual situation. Dr Laker—I think the view would be that if the regulated entity felt that there were no breaches of confidence in that report and released it themselves, that would be their call, but we cannot on our own initiative release matters which are commercial-in-confidence. Senator CONROY—When was your last on-site visit to NAB before the losses were announced? Dr Laker—There had been a series of on-site visits to NAB and to all of our regulated entities with large treasury operations. The market risk focus of APRA is a constant focus. The sequence has been that there were market risk visits in August 2002 and a follow-up visit in August 2003, and there were scheduled visits to follow up on issues that we had outstanding with NAB before this particular episode was identified. Senator CONROY—In August 2003 you visited them? Dr Laker—They were follow-up visits. Senator CONROY—Follow-up visits arising from 2002? Dr Laker—It is on a regular cycle. It did not just start at one point of time. We have been in discussions with all of our banks with major treasury operations over many years, so there is a cycle. CHAIR—What is a follow-up visit? Does that suggest a briefer visit or a less thorough examination than the visit to which it is the follow-up? Dr Laker—If I speak in general terms, you can understand why it is— Senator CONROY—He is a lawyer. You have to excuse him. CHAIR—Unlike you, Senator Conroy, some of us are actually concerned with defining things. Dr Laker—In any market risk visit to major institutions, even with well-structured risk management systems, APRA will invariably find areas where it can push for improvement and for best practice. A program to get to that would be agreed, and then the follow-up is part of our program to ensure that commitments made to improve risk management systems are followed up and that they deliver the results that we look for.

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CHAIR—So it is a checking mechanism to supervise something which had been established? Dr Laker—If we raise issues that we think require improvement or addressing, we do not simply put them on the table and walk away. We follow that on an agreed timetable. That is the way we approach this part of our supervision of any of the major institutions. Senator CONROY—That was well defined. Does that visit cover regular surveillance of a bank’s trading book activity, or do you have a different mechanism for looking at that specifically? Dr Laker—As I said, we do not sit on the trading desks. We do not run the trading operations of these institutions. But the market risk supervision covers by definition all of those various trading activities that a financial institution would undertake. We look at the governance framework in place to make sure that the risks arising from that trading are identified, monitored and controlled. Within each of these trading activities, we will look at the structure of limits and the way in which, if there are breaches, these breaches are handled, what is the governance framework and what gets reported to the board. Senator CONROY—So when was the last time you looked at the NAB framework? I appreciate that you made your scheduled visits and then your follow-up visits, but when was the last time you had a look at this aspect? Dr Laker—When you say this aspect, what do you mean? Senator CONROY—The trading book activity, the sort of thing you have just described. Dr Laker—That is the process of our market risk supervision. When I talk about market risk I am talking about risk coming out of their trading operation. So it has been an ongoing process with NAB over some time. Senator CONROY—No doubt you would be familiar with the Basle Committee’s Core principles for effective banking supervision. Principle 12 states in part: Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor and adequately control market risks; Dr Laker—Yes. Senator CONROY—In an April 2001 self-assessment, APRA stated that it was compliant with this principle. I think this was probably pre your arrival, Dr Laker, but a few of the other officials might have been there. Part of the self-assessment said: Although APRA’s on-site work does not involve transaction testing, a key component is an assessment of the work done by banks’ own internal-audit functions in ensuring that all genuine (and only genuine) transactions are processed on a timely basis, and that independent revaluations are occurring using appropriate data. Prior to the NAB’s disclosure of the forex option losses, was APRA satisfied that the NAB had appropriate systems in place to control market risk? Dr Laker—Can I offer a simple answer to that question, but then I would have to say that I would be getting into the area where I am starting to get close to my disclosure obligation. Let me say that we had identified concerns in the risk management framework of NAB. We had

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 17 expressed those concerns to the NAB board and management and they were responding to these concerns. Senator CONROY—When was that? Dr Laker—Over the course of the last 12 months, I would say. We have been in a constant dialogue on these issues and, as I say, they were responding to those concerns when this particular episode was identified. Beyond that, I would need to see the results of the inquiry before I could comment any further. Senator CONROY—So you had identified some concerns—I will just leave it at concerns, we do not want to get too defined for Senator Brandis. Dr Laker—We had identified issues that needed to be addressed. Senator CONROY—You had identified concerns around these areas. Dr Laker—Yes, around the risk management framework. Senator CONROY—Yes, thank you for the clarification. Sorry, Chair, do you need another definition? CHAIR—Yes, I do, as a matter of fact. There is a difference, isn’t there, between having an identified issue and having an identified concern? To me a concern suggests that you are alarmed about something. Senator CONROY—Alert, not alarmed! CHAIR—Whatever. An issue might suggest no imminent concern at all, merely something that, almost as a matter of routine, needs to be attended to. Was it an issue or a concern? Dr Laker—I am not a lawyer, Senator; I will give you the word ‘concern’ as the appropriate description. CHAIR—Thank you. So you had concerns? Senator CONROY—How long do you allow before you decide the concerns are not being addressed? With the first cup of tea, you get a chockie biscuit; with the second cup of tea, there is no biscuit; with the third cup of tea, there is no tea. Dr Laker—Senator, the prudential scone went some years ago. It is difficult to give you a simple answer to that, because it depends on the nature of the problem that is identified. For example, if we identified issues about the IT systems and how they talk to each other—if we identified concerns about how they talk to each other—the program to rectify that can take some time. If we identified a framework of limits which we felt were not rigorous enough, then each institution has its own process by which it goes back to its board for approval of a new limit structure. We need to understand what that process is. But we do not take a leisurely approach to this. We do agree a firm timetable. It has got to be a realistic timetable. And we press, because where we have concerns they need to be addressed as soon as possible. Senator CONROY—Bear in mind that I am not asking about what has transpired from the point of notification and then your investigation. My question is addressed to pre their advice to you. Were you satisfied they were addressing your concerns speedily enough? Dr Laker—I am reluctant to get involved in the details of the—

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Senator CONROY—I am asking about pre the incident. Dr Laker—Pre the incident? Senator CONROY—Pre them coming and knocking on your door and saying, ‘Whoops, we have just lost $400 million.’ I am saying that you had raised concerns with them some considerable time ago. Were you satisfied that they were moving fast enough to satisfy your concerns? Dr Laker—We had agreed a timetable with the NAB to address those concerns. They were working within that timetable and issues were being addressed and resolved within that timetable. Senator CONROY—This is maybe a little hard to answer just yet, but I promise you I will come back to it next time. Say they had addressed your concerns prior to when it appears the losses started occurring in October—you may know a different date, but I think it is generally accepted out there in the market that October was when the first losses started racking up. If they had addressed those concerns faster, would those losses have been incurred, in your view? Dr Laker—I will wait for that question next time. Senator CONROY—I appreciate that it may be too early to answer that question, but I promise you I will come back to it. Dr Laker—To give a considered answer to that question, I think we need to understand exactly what was happening in the trading operations and the risk management checks and balances over that period. As I say, we are still investigating that and so is PricewaterhouseCoopers. I will answer that question when we are in a position to do so. Senator CONROY—I appreciate that we do have a number of constraints here. You cannot identify what your concerns were, although you have given a bit of a picture. We have not established exactly what the failure was—not until after the report has come through. I appreciate that you are not able to be much more definitive than that. Dr Laker—Not at this point. Senator CONROY—So in that same 2001 self-assessment report APRA stated: APRA does not, at present, impose direct limits on market-risk exposures (eg net-open-positions limits for foreign exchange). Instead, APRA relies on institutions implementing, and adhering to, their own appropriate internal limits as the primary means of control, supplemented by the market-risk capital charge. However, APRA has the authority to impose such limits if it was deemed necessary. You would be aware that some commentators have questioned whether the banks should be in the business of trading in derivatives on a proprietary basis at all, as distinct from doing so on behalf of their clients. Does APRA have a view on this issue? Dr Laker—I am not sure APRA has a view. I can give you my view, having been involved in this area from the mid-1980s when, at the time, the supervision of foreign currency options was a Reserve Bank responsibility and where initially there were what are called open position limits imposed on the spot and forward positions of the trading banks and other authorised forex dealers.

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We needed to look at the issue at the time of whether banks should be able to write and trade in foreign currency options. The bank looked at the risks involved and the way the market was developing and started from the view that well-managed options form a natural part of the hedging instruments that are available to banks and to their customers. There was no decision at that point to not allow banks into that market and banks were given approval to do so, but there was a supplementary set of limits on the trading. The market has evolved from that point. It is a market in which the bulk of trading is interbank; it is not customer based. But that is no different from the nature of trading in the foreign currency market as a whole. If you look at the turnover in the foreign currency market you will find about 80 per cent of it is— Senator CONROY—I am asking whether a bank should trade in its own right—not on behalf of its customers but in its own right. Don Argus has described this sort of derivatives trading by banks as ‘taking the bank’s balance sheet to the casino’. Dr Laker—If the risks are not managed carefully. I think we need to be careful about what we call proprietary trading. If a customer does an options deal with the bank and the bank writes an option for it and the bank wants to cover that position it goes into the interbank market to try to cover its position. That process can generate a range of interbank transactions in options and in the spot market as each of the institutions position themselves to manage their risk. That will continue until the risk on the options is ultimately passed to the one party that is prepared to hold it. That is the natural way in which the foreign exchange market works, and that one customer transaction can lead to a series of interbank—or what you would call proprietary—trading transactions, to make sure that the risks are ultimately transferred to the risk bearer. To get back to your first question, the framework that is in place in the market risk area is as described there. The idea of setting individual limits for open positions in the spot book and the options book was over time replaced by the market risk framework developed within the Basle context. Those first sets of limits were pretty blunt and unsophisticated attempts to define risk. The market risk framework is much more sophisticated. It requires a lot more statistical modelling. It requires banks to identify the maximum amount they would be prepared to lose if there were to be an adverse movement in exchange rates. APRA looks at those models— Senator CONROY—NAB have given you a figure? They have said, ‘We are prepared to lose this much.’ Dr Laker—They publish a figure themselves. It is what they call ‘value at risk’. Senator CONROY—What is NAB’s published figure? Dr Laker—I would have to go back to the numbers. Senator CONROY—Is it more than 400? Dr Laker—It is less than 400. I think what they publish as the risk they would be prepared to lose is for a one in 100 years event, or a one in 100 days event, depending on the period they use.

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Senator CONROY—One hundred days is probably more appropriate than 100 years for foreign exchange trading. Dr Laker—I think one in 100 days is the right figure. We examine those market risk models in detail: we look at how rigorous they are, we look at their tolerance for risk and we look at the risk controls that are around the models and around the trading. That is described in the self-assessment. Senator CONROY—I appreciate the point about a customer going to the bank and taking out a hedge and then they go and hedge against that. That is a customer generated trade rather than a proprietary trade. There is a substantial difference. You can clearly define between the two, can’t you, in terms of the information you have or the knowledge you have? Dr Laker—In terms of the limits the bank will put against what it would call proprietary trading. Senator CONROY—Is this limit we are talking about a limit on all trading or is it a limit on proprietary trading? Dr Laker—There is a structure of limits. Our focus is clearly on the overall risk that the entity is taking by its operations in foreign currency options. Senator CONROY—So there is a delineation? Dr Laker—My colleagues at the coalface can tell you what the specific structure of limits looks like for individual institutions, but limits were generally imposed by boards on so-called proprietary trading in my time. I think others can confirm that. Senator CONROY—Are there any takers? Mr Karp—That is correct. Institutions would normally have limits on total trading and total risk in the whole book and the different types of risks—not just value at risk but other types of risk that they are running in the book, such as volatility risk or time risk. They would normally also have separate limits for trading in the total book and trading in the proprietary book. One of the other points that probably should be mentioned here on this issue is that banks will often need to deal in foreign exchange themselves to hedge their own positions, not just because of customer trades but because of foreign currency exposure that they have on their own balance sheet. For example, if they are raising debt in offshore markets in US dollars, they will want to do some hedging themselves to bring that risk back to Australian dollars. So it is not just customer trades that they are hedging; they are hedging some of their own balance sheet risk. Senator CONROY—I am sure you have seen most of the media around. There was quite an entertaining article in the Financial Review just recently about how NAB had taken off the cardigan, thrown on the flash, shiny suit and wandered off in this direction, whereas traditionally they were a lot more risk averse. What probably got them through the problems in the 1990s better than anybody was that they were fractionally more conservative, but the law of the dollar, as the Financial Review said, made them cast off their cardigan. You may not have this information, Dr Laker or Mr Karp, but in the last few years did they up the limits that they were prepared to lose? Have you noticed a creeping up of those limits?

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Dr Laker—Can I answer the question generally, and then we can answer the question specifically. I think the article you were referring to seemed to have identified that Australian banks borrow offshore more than they did in the past. It is curious that that article came out when it did, because the Reserve Bank had addressed that issue some months earlier. In fact, it has highlighted the change in the way in which banks have funded themselves in every annual report in the last four years. This is not new; this is not a fact that has just been discovered. The fact is that Australian banks now raise about one-quarter of their funds in offshore markets. That is a natural diversification of funding sources; it is not in itself a prudential issue. Within what they borrow offshore, about one-third is in Australian dollars, so there is not a foreign exchange risk anyway. The remaining two-thirds is in foreign currency, but it is swapped into Australian dollars so that it is fully hedged. When the Reserve Bank looked at the exposures that ultimately resulted from all of this—the risks there were to the banks from movements in the exchange rate—they were very small. In fact, when they did their surveys, the Australian banks actually had a surplus position in foreign currency. They were not in deficit. The borrowing is fully hedged. There has not been a risk of an exchange rate move. The risk to those banks would be when, for some reason, those wholesale international markets thought that Australia might be on the nose or that one particular Australian institution was on the nose. What that would do would be to have an exchange rate and interest rate impact. It would require the banks—or force them—to bring that borrowing back onshore. The Reserve Bank’s judgment was that this would put some pressure on interest rates, but only at the margin—at the short end. It was not a major issue. It was not one that could not be handled by economic management. So I think we need to cut through the sudden surprise that Australian banks are offshore borrowers. It has been the way in which they have funded their growth. Senator CONROY—The second part of my question was whether you have noticed over the last few years—I think Dr Laker said they publish some aspect of the information in the annual report—whether these acceptable loss limits have risen in recent times. Have you noticed anything, Mr Karp? I think you have supervised in this area for a while on and off. Has there been a noticeable increase? Mr Karp—The short answer is that there has been, across the market overall. Senator CONROY—I appreciate that. Mr Karp—While it has varied a little from bank to bank, the overall increases are very much in line with each other. There is nothing that is significantly out of line. Senator CONROY—Principle 13 of the Basle committee’s core principles states that Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor and control all other material risks and, where appropriate, to hold capital against these risks. In the April 2001 self-assessment, APRA stated that it was largely compliant with this principle. APRA noted that it was deficient in that it did not have in place any standards for operational risk, although work was underway in the area. It stated: Despite the absence of formal standards, the review of balance-sheet and operational risk-management systems remains a key component of APRA’s supervisory assessment process.

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How is APRA progressing in developing these operational risk standards? That was taken from April 2001. Dr Laker—I am sorry, I missed the question. I heard the lead-up, but I missed the question. Senator CONROY—How is APRA progressing in developing these operational risk standards? This is a self-assessment from back in April 2001. Dr Laker—The operational risk standard was introduced— Mr Littrell—Broadly speaking, operational risk comprises two flavours: outsourcing risk and in-house risk. We have introduced outsourcing standards formally for the ADI sector and intend to do that for other sectors. In terms of the in-house operational risk, we are working particularly with the banks who are looking to move to the Basle 2 advanced model. Senator CONROY—So do we have the standard yet? Mr Littrell—We have the outsourcing standard. The standard for in-house, which is what this was, is in development in the context of the Basle 2 process. That is still in development. Senator CONROY—But this was back in April 2001. Mr Littrell—That is correct. Senator CONROY—It says: Despite the absence of formal standards, the review of balance-sheet and operational risk-management systems remains a key component of APRA’s supervisory assessment process. But nearly three years down the track we still do not have a standard. Mr Littrell—No, we are moving in coordination with the international bank supervisors in terms of an international standard. Senator CONROY—Have the other OECD bank supervisors put in place an operational risk standard yet? Mr Littrell—We are all working to the same set of rules in Basle 2, so there has been a lot of progress in terms of our on-site supervision of operational risk but, in terms of a published standard, there have been a series of drafts. But that is not going to— Senator CONROY—So have any other OECD countries promulgated an operational risk standard yet? Mr Littrell—They could have. I am not familiar with what all of them have done, but what one might call the general global standard is not yet out. Senator CONROY—So it is possible that they all had their existing local standard, even though we have not got one? They might have had them, albeit working towards what you described as the ‘global standard.’ Mr Littrell—No, not all other OECD countries have a formal ops risk standard. Of the 20 or 30 OECD countries, I do not know what they all have, but it would not be typical if they had a formal operating risk standard.

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Dr Laker—This is an area in which a lot of work is currently being done globally because it was one area that really had not been formalised as much as credit risk management or market risk management. We need to operate in a framework that is agreed internationally, and there are various methods that are being looked at to try to quantify and hold capital against operational risk. But at the same time we do not wait for the standards. We have actually got an operational risk team that is in the major institutions as a specialist team, looking at operational risk and going through, where we identify a range of operational risks. So it is a very active part of our consulting work. Senator CONROY—Could you get back to us about which OECD countries do have operational risk standards. Mr Littrell—Sure. Senator CONROY—Thanks. APRA’s prudential standard, Prudential Standard APS 310—Audit & Related Arrangements for Prudential Reporting, requires bank CEOs to provide APRA with an annual attestation that the management control systems are in place adequate for the bank’s needs and operating effectively. Did APRA receive such an attestation from Frank Cicutto last year? Mr Karp—I would need to check precisely, but I believe we did. We normally do get them from all the banks that are required to provide them. Senator CONROY—What are your processes to verify the accuracy of that statement? I presume he just sends the letter and says, ‘Everything is in order.’ What do you do to check? I know you have mentioned that you have had concerns, and this may overlap with that issue. Mr Karp—A lot of it does, because essentially the way that we do as much checking as we can and get as much comfort as we can is from our process of onsite visits where we look at all sorts of different aspects, ranging from credit risk, traded market risk and operational risk generally. So it is all from that regular cycle of visits. We obviously cannot check everything in the large and complex banks on a very frequent basis, but we do touch different parts of a bank over a cycle. One of the other things that is done is that once a year we identify an area of operation of the bank that we require them to get the external auditor to specifically look at and to provide a report to them about, with a copy to us. Our visits, plus this yearly tripartite review, as we call it—because the scope of that is actually agreed between us, the bank and the external auditor—are designed to help us get a bit more comfort that we are testing different parts of the bank at different times; but we clearly cannot test all parts every year. Senator CONROY—I appreciate that you may not be able to give me an exact date, but when did you first advise NAB that you had concerns about their operational risks? It would be good if you could give me an exact date, but I would be happy with a month. Mr Laker—The discussions that gave rise to our advice to the board and to the senior management of NAB go back some time, because the discussions arose out of the onsite visit process that was undertaken. Senator CONROY—That was the August 2002 visit?

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Mr Laker—There was a fair degree of dialogue and fact-finding and clarification that was done after that. Let me say that it was in the first half of last year. Senator CONROY—The first half of last year? Mr Laker—Yes. Senator CONROY—When Mr Cicutto sends you a letter saying, ‘Everything is adequate,’ and you have expressed concern, how does that work? You said to him, ‘We’re not quite sure. We’ve got a few concerns.’ And he writes back and gives you a statutory statement that he is required to give under your regulations saying, ‘No, the management controlling systems in place are adequate for the bank’s needs and are operating effectively.’ How does that gel? You tell them you have problems in the middle of last year. They write to you and say, ‘Everything is cool,’ and you just tick it off? Mr Karp—I do not think it is anywhere near as simple as that. The fact is that what we are achieving via the attestation process is to bring the CEO and the board’s focus onto these issues, so that— Senator CONROY—Was it a qualified attestation? Did he write back and say, ‘Aware of your concerns. Working on them. It is adequate,’ or did he just send the pro forma they send you every year? Surely it must have been qualified. Given that you have spent six months telling them you have got concerns, surely he wrote back and gave a qualified attestation—or was it just a case of changing the date, roneoing it off and sending it in? Mr Karp—These attestations have to be done in the context of materiality, like most of these things. So even though there will be areas where we have concerns and we are pushing them on, in the overall context of the bank, the board and the management can still take a view that they believe everything is okay, even though there are issues and concerns that we have. Senator CONROY—This is private correspondence going back and forth. It is not as though you are going to publish it on your web site, although from the sound of it we might get some enjoyment and amusement from making them do that. They could acknowledge the fact that you are in discussions with them and that you have concerns. The attestation process just sounds like a farce, given that you have spent six months telling them that you have got concerns, you are working on solutions and you have set a timetable for them to fix them— and they send you a letter saying that everything is fine. Does it sound like there is a point? Mr Karp—As Dr Laker said earlier, with virtually every visit we have to a major institution we find something that is not working the way we would prefer it to work and we pursue that with them. I do not see that that means that they have to have a totally clean slate and be 100 per cent clear of any concerns or issues that we have in order for them to give an attestation that basically they believe that the risk management controls and systems in the institution are adequate. Senator CONROY—It does appear they were wrong, though, doesn’t it? Mr Karp—Yes, it does.

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Senator CONROY—It would have been nicer if you had been able to send a letter back saying, ‘Hey, just a minute, Frank. We don’t think so.’ You didn’t send a letter back, saying, ‘Oi! We’re not sure’? Mr Karp—Well, I suppose the only answer to that is that Mr Cicutto is no longer there. Senator CONROY—The NAB has claimed that there is an industry wide problem with the valuation of derivatives like foreign currency options. This claim has been disputed by some in the industry. Does APRA agree? Dr Laker—The question of revaluation of illiquids is the issue that I think the market has been talking about. There are two views out there. One is that this is a difficult area because, as some of these options are over-the-counter options, they are in a sense tailored. There is another view, though, that you can find revaluation rates from independent sources. I do not want to comment on that particular one. I do not have enough knowledge of the market practice in that area, but I do— Senator CONROY—NAB were saying that it was an industry wide problem. They were not talking about their own specific— Dr Laker—No, but some in the industry are saying that it is industry wide and some in the industry are saying that it is not. So I am not quite sure what is industry wide in that case. Senator CONROY—But it is NAB wide. Dr Laker—The question of revaluation of foreign currency assets is an important issue in the context of this inquiry as well. As you know, when the NAB revalued its book— Senator CONROY—My question to you is: do you think there is a problem in measuring these things? Dr Laker—I do not know enough about the specifics of trading foreign currency options to be able to offer a comment about the market. Senator CONROY—How do you know they are inside the limits if you do not know how to measure them? Help me here. If you don’t know—I don’t mean you personally but APRA—how do you tick off that— Dr Laker—The question is: what is the process within an institution for making sure that it can value the risks on its options books, particularly when these options might not be plain vanilla type options? What we look for is a rigorous process, separate from the dealing areas, where independent valuations can be brought to bear and some other committee or group is looking at how to value those processes. So we look to see how the institution goes about satisfying itself that it has a good valuation process. Senator CONROY—But your job is to measure if they are inside their limits, and you have no independent way of really testing that. Dr Laker—As I say, we are not sitting in the trading room. We are looking at the governance process around how institutions measure these risks and we need to be satisfied that is not just by putting a finger in the air. We need to see how they go about that process, and there are methods available.

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Senator CONROY—I do not want to embarrass the organisation, but a senior figure in one of the big four accounting firms said to me, ‘Look, no-one over the age of 50 has a clue how to value these things. They have to hire some 25-year-old straight out of uni who has a remote clue about how to value them, because they are just things that are not in their training by definition. It is a relatively new phenomenon.’ Major accounting firms privately acknowledge that this is a very hairy area. So when NAB says, ‘There is an industry-wide problem with the valuation of derivatives,’ that is a real worry. It is a worry at the individual level, but I am asking you about the prudential supervisory level. If APRA does not have a capacity to understand how to value these things it would be hard to pick up a signal if there was a problem, wouldn’t it? Dr Laker—Our specialist market risk team comes out of the under-50s market experienced areas. I am disqualified by your cut-off. We have industry specialists who, in their assessment of the market risk framework, look at how banks go about that revaluation process. I do not have my specialist here; he is on the case at the moment at the NAB. We need to be satisfied that the process of revaluing the book is as objective as possible, looking at the potential losses in the book and making sure that that information is communicated up the line. In the end it is the responsibility of the board to satisfy itself that it knows what business it is getting into. Senator CONROY—My very next question goes to that issue. APRA has emphasised that the banks’ boards have the prime responsibility for ensuring appropriate risk management. Does APRA think boards are equipped to do the job? There have been calls for boards to include people with understanding of derivative instruments—particularly, I guess, in financial institutions. Is that something you will look at? Dr Laker—I think it is something that APRA has looked at over the years in terms of the— Senator CONROY—I note you have a draft prudential standard for board composition on your web site. Would you consider amending your prudential standard in the light of the NAB experience? I think NAB’s chairman has put up his hand and said, ‘We’ve basically got not banking experience on here and we need to get some banking experience on here.’ Would APRA like to encourage the banks to have somebody who understands their business on their boards? Dr Laker—As a general point, we have been seeking to encourage the boards of any of our regulated entities to have on board the skills necessary to understand the business. Senator CONROY—Given that the chairman has now resigned, taking the ultimate responsibility for a failure to do just that, is there a need to change your draft prudential standard and try to do more than just encourage them? Mr Khoo—I would like to make a point. We have been looking to try and improve the quality of board composition and the like across all industries. I think it would be unrealistic to expect the board, with the number of personnel it has, to be able to cover every single area of risk these days.

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Senator CONROY—Are there many parts of the operation where you can lose $400 million in three months? Can retail banking or home loans lose $400 million in three months? Mr Khoo—Coming back to the question you asked, the point I was trying to make is that it is always open to a board to seek the expertise to assist them without actually having the direct personnel there themselves. They can always bring on board the expertise to assist them in that regard. Senator CONROY—Given that you have been expressing concern to them about their risk management systems, they seem to have ignored the point that you have been making to them about experience. Dr Roberts—I think the mechanism we have in process for addressing your question about board competence is our fit and proper standards which, in the banking area, are under development. But in the general insurance area, where we put them in earlier—applying to directors and senior executives—there is something to the effect that the board should collectively have competence. Senator CONROY—As you know I have had a long interest in the fit and proper test for banks in particular. Dr Roberts—Yes, you have, Senator, and I think you have been very keen to have a comprehensive and effective fit and proper regime in place for banking. Senator CONROY—What a pity for NAB shareholders I was not able to succeed faster. Dr Roberts—I think we are working quite hard at present to accommodate you in that. Senator CONROY—The report has indicated that the suspended traders received hefty bonuses recently—in the period before the losses were disclosed. Do we have to look at the remuneration structures in relation to this sort of trading and the perverse incentives that it creates? Do you think there is a problem with the way incentives are structured? Dr Laker—I think that when the inquiry by PricewaterhouseCoopers is completed and published, in whatever form, it will raise issues which require industry wide consideration. One of the issues will be reminding boards that they need to understand this kind of activity. You asked about how else you could lose that much money in a short space of time. I would not want to embarrass NAB, but they had other episodes where they lost large amounts— considerably larger amounts—elsewhere. But— Senator CONROY—I don’t think you should be shy about trying to embarrass the NAB board, frankly. Dr Laker—I am a very proper person, Senator. But what it will do is focus the industry’s attention on issues about boards’ understanding of the risks undertaken by their institutions and it will obviously focus on questions like remuneration structures. But we need to see what the facts were in all of that area, because much of it is just market speculation and I can only go on what I see in the report when it is finished. I think it will echo through the industry. We will certainly have a look at whether we need to— Senator CONROY—We are hoping you have got the megaphone, Dr Laker.

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Dr Laker—Yes, I know, and when we say the fit and proper standard is in development it is very close to coming out. Senator CONROY—You would have seen reports that the market had expressed concern to the NAB board about some of the positions being taken. Were any of those concerns that were reported to NAB reported to you at any stage? Dr Laker—That issue about what was or what was not reported to NAB is part of the inquiry, so let me wait until we see what the facts are. Senator CONROY—But my question was: were any concerns raised with APRA about the position being taken by NAB in the forex market? Dr Laker—No. Mr Karp—I think the short answer to that is no. Dr Laker—I think there is an important need to cut through what is speculation and what is fact and that is what the PwC report will do, on that particular point. Senator CONROY—It has been reported that NAB’s average value at risk disclosed in its annual report was almost twice that of ANZ, CBA and WBC combined. I am assuming APRA were aware of that? Dr Laker—Yes, that is true. Senator CONROY—Was that one of the issues that prompted you to raise your concerns? Dr Laker—The figure, though, is $22 million average daily value at risk. It is true that it is double the size of the other three, but in absolute terms it is $22 million. Senator CONROY—Whistleblowing is the wrong way to describe this, but the question of APRA picking up market intelligence is a very sensitive issue, following HIH. Dr Laker—Yes, I appreciate that. Senator CONROY—Anyone can say ‘Oh yes, I let NAB know,’ but you will be able to get to the bottom of whether the NAB board were aware of anything. If the NAB board had been made aware—and this is not to cut across anything you do—is there a requirement for them to have let you know? Should there be a requirement for that sort of information to be passed to you? How do you pick it up? You can understand that after HIH people are particularly wanting to make sure that APRA are in touch with the market and know what is going on. So I am looking for you to reassure us that there is some mechanism by which you are able to pick this up, other than by buying the newspaper. Dr Laker—APRA can pick up that information on those sorts of concerns through a range of mechanisms. Let us leave aside the facts or otherwise of that particular event. One of the mechanisms is day-to-day involvement with regulated entities across the board. We get quite extensive and informal feedback from all of our regulated entities, day in, day out, and if the issues were material we would expect to be notified by the entity concerned. Senator CONROY—Is 300 in a bank the size of NAB material? I know that in absolute terms of dollars it is a large amount, but is it material?

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Dr Laker—To go back to the Senator’s very first question to me: it is not the amount but the way in which it arose that is material, and that is why we were notified as soon as this amount was identified within the NAB. Through our specialist contacts and our frontline contacts, we are on the phone every day to the regulated entities. We also have informal and formal arrangements with the Reserve Bank to pick up what they hear in markets about market concerns, because we are not trading in the markets. Senator CONROY—But from what Mr Karp said a few moments ago it seems that you did not pick up anything odd about NAB’s trading pattern. Mr Karp said that you had not heard anything from anybody. Dr Laker—No, we had not at that point. Senator CONROY—I have one other bracket of questions, to do with low doc loans, but I am happy to put them on notice. I do want to talk about corporate governance issues, so I might see if I can get you to appear before another committee to have a chat about some of your suggested corporate governance reforms. As you know, that is another area of deep interest to me, and I am very keen to explore those with you to see where they are going. Dr Laker—We are happy to come back to you on low doc loans, because, as you know, that is something we are reviewing right at the moment. Senator CONROY—You have put out a paper, and that is one of the reasons why I want to talk about it. Dr Laker—If you want to do that, may I encourage you to do it earlier rather than later, because our processes are moving on in that one. Senator CONROY—I will see if I can drum it into another parliamentary committee to call you before that. Dr Laker—We would be happy to get back to you on that one. Senator CONROY—Thank you very much. CHAIR—Thank you very much. Dr Laker and gentlemen. You are excused. Proceedings suspended from 10.21 a.m. to 10.37 a.m. Australian Competition and Consumer Commission CHAIR—I call the hearing to order. I welcome to the table Mr Samuel, the Chairman, and officers of the Australian Competition and Consumer Commission. Mr Samuel would you like to make an opening statement? Mr Samuel—Thank you. I welcome the opportunity to comment on some of the practical aspects of the ACCC’s operation. I will not address in detail some of our regulatory areas— insurance, airports, telecommunications, energy, transport and our informal petrol price monitoring—as perhaps they can be dealt with in questions. I want to deal more generally with two or three significant topics that encompass a broad gamut of our operations. The first relates to enforcement and compliance, the use of the media in that context and our leniency policy. I then will move to some of the areas relating to small business, focusing particularly on the recent report we issued on the assessment of the petrol and grocery sectors and the shopper docket petrol discount and acquisition schemes that was issued just a few days ago.

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The enforcement side of our operation is the sharp point of what we do; it is the crux of our operation. If that is blunted in any way then the ACCC should simply fold up its tent and disappear because, without enforcement, the law—which is so important to virtually every transaction that is entered into between business and consumers or business and business on a daily basis in this country—becomes ineffective. So we view enforcement as the pinnacle of our operation. Last year we received through our infocentre 53,532 complaints. We therefore have to put in place methodologies and processes to deal with those complaints in the most effective way, setting in place certain priorities such as stopping the damage and the consumer harm as soon as possible. CHAIR—What proportion approximately of those are consumer protection related— presumably, the vast majority? Mr Samuel—I could not give you a percentage, but I think the vast majority relate to consumer protection. I will perhaps come to cartels and some of those activities a bit later on, but the vast majority relate to consumer protection, about which I will give some statistics a bit later on. We resolve a vast number of those by means other than having to go into an investigatory stage. They are resolved by quick phone calls and/or letters, communication and/or visits, as may be appropriate. The primary objective is to stop the behaviour and to stop the consumer harm as quickly as possible. Where it is legally possible, we want to obtain restitution for consumers where they have been harmed, and we want to prevent recurrence of the behaviour. Our actions are directed towards breaches where there is a widespread consumer detriment, as distinct from a single issue which might involve a single consumer suffering a harm that may not be affecting a broader spread of consumers. Our actions are directed towards deliberate breaches, emerging trends in industries and business sectors and towards repeat offenders. I have called them before the recalcitrants. There are a number of instruments that we use to complement one another in dealing with the area of enforcement. They work interdependently and they promote conformity. No single part of our enforcement process can be effective in isolation. The first I want to reflect upon is working with the media—use of the media to bring about behavioural change. We do that unashamedly. We believe that, by informing consumers about our activities, by informing industry sectors of concerns we have about specific actions or specific conduct on the part of those sectors that are in breach of the act, we can bring about behavioural change very quickly and then follow that up with some of the other complementary elements of our compliance processes. Perhaps the best and most recent example of a very effective use of the media in this context was in the property industry. Towards the latter half of last year, in September, we issued a press release which essentially said that we were concerned about a number of misleading and deceptive practices in the property industry ranging from dummy bidding and underquoting at auctions through to wealth creation and property marketing schemes and two-tier selling operations that were occurring in relation to property schemes. We indicated that we were setting up a project task force to deal with these issues, and there were a number of very interesting results. From the real estate industry, the initial reaction was one of disbelief that we would even be querying issues such as dummy bidding

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 31 or underquoting. After all, this had been a normal practice in a range of areas of real estate auctions for many years. We were very quick to say that we regarded it as misleading and deceptive conduct and that we would prosecute not only estate agents involved but also vendors and their aunts and uncles, nephews and nieces and brothers and sisters if they were involved in dummy bidding. Very quickly—within a matter of days—one or two of the real estate institutes put out new behavioural codes of conduct which said to agents, ‘No longer is dummy bidding or vendor bidding to be acceptable conduct in the course of auctions.’ We have commenced a court action in relation to an underquoting situation in Victoria where a property was quoted by the agent as ranging from between $600,000 and $650,000 and was ultimately passed in at auction at $780,000. We have indicated that, in our view—this matter is currently before the courts—we allege that that is misleading and deceptive conduct. We said that we were focusing on property marketing schemes. We instituted proceedings against Mr Henry Kaye and the National Investment Institute within three weeks of our public press release, including the gaining of significant expert information as to the validity of these schemes, and whether the scheme that was being promoted by Mr Henry Kaye and the National Investment Institute was a scheme that, in advertisement terms, was misleading and deceptive conduct. Mr Kaye and the NII very quickly gave court undertakings that they would cease the advertising of those schemes and that they would take it off the Internet site. The result of that was that some of the seminars promoted by Mr Kaye were cancelled. You may have noticed in the Sunday newspapers that many of the other promoters of these schemes actually withdrew their advertisements from the newspapers. Many of the seminars themselves were cancelled. Ultimately the National Investment Institute went into voluntary administration and only yesterday creditors voted for it to go into liquidation. Mr Kaye advised publicly at the time that it went into voluntary administration that the drop-off in attendance at the seminars had been a major factor in causing some cash flow issues which ultimately caused the liquidation of the National Investment Institute. We regard that as a relatively successful campaign at this stage—there is still more work to be done—to try and clean up some areas of the property industry where we have jurisdiction, as distinct from the jurisdiction that ASIC might have in this area. CHAIR—I was just going to ask you that: wouldn’t there be borderline jurisdictional issues between you and ASIC when you embark on an investigation like that? Mr Samuel—There are, but I think that the jurisdictional issues are probably clearer than might otherwise be seen to be the case. The issue that we took Mr Kaye to task on was what we alleged was a misleading and deceptive advertisement which related to the promotion of a property seminar—it was actually a free property seminar, I might say; it was one of the first ones that he was promoting as a free seminar—that was promising to make investors property millionaires with very little investment of equity and no debt over a very short period of time. We regarded that as misleading and deceptive conduct and that fell within the purview of our jurisdiction. The actual conduct of the seminars themselves and some of the alleged linkages that occur between the promoters of these seminars, property vendors, lawyers, valuers and the like is more a matter for ASIC under its jurisdiction with the carve out of financial services that occurred following the Wallis report.

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Our first campaign for this year is on Internet scams. We think that the Internet has now become the prime source of communication between some of the fraudsters in the market and consumers. We were involved, between 12 and 15 February, in an international Internet sweep involving 24 regulatory agencies throughout the world plus a number of regulatory agencies in Australia. We were doing a sweep to look for pyramid selling schemes, work at home schemes and medical claims. We all receive them in our spam email, I am sure. That has led to a number of sites being brought to our attention. They will be the subject of communication with the promoters of the sites concerned. Ultimately, if we can demonstrate that there is misleading and deceptive conduct then prosecutions will be undertaken. Part of this also is an educational process; it is to make consumers more aware that if these Internet sites fail the test of the question, ‘Is it too good to be true?’ then it probably is too good to be true. It is that sort of educational process that we are going through at the moment. We are committed to a national consumer protection campaign. I emphasise the word ‘national’ because where there are local issues to be dealt with we will tend to pass those over to the local office of fair trading or consumer affairs offices of the various states. That is the appropriate way for those to be dealt with. We have a range of instruments to deal with compliance. There is the well- known ‘pyramid of compliance’—the one that was first discussed by Professor Braithwaite some years ago. The base of the pyramid is education and information of those in business as to what compliance with the act is about. It clearly is better to have businesses complying with the act than to retrospectively prosecute them for breaches of the act. By then the consumer harm has been done and it is very difficult to provide total restitution for consumers in those circumstances. The second tier of the pyramid deals with compliance culture and strategies within organisations. The compliance culture starts with the CEO and moves all the way through the organisation. We have a branch of the ACCC’s activity that focuses extensively on compliance and compliance strategies within organisations so that those in all tiers of the organisation—from the chairman and CEO right the way through—understand that compliance involves more than simply ticking a box; it involves understanding what the act is about and the way the ACCC operates. The next level of the pyramid is negotiated settlements and section 87B undertakings. A large number of our cases are resolved by that process. Then, of course, the final sharp point of our compliance pyramid is litigation. Just to give you a feel for this matter, I mentioned there were 53,532 complaints and inquiries last year. Of those, 26,000 were resolved during the initial contact—that is, by a quick telephone call or letter; 634 were escalated to an investigation stage; and 262 went to serious investigation. Of those, 39 proceeded to litigation. I mention that in the context, if you look at those statistics— CHAIR—Does that include section 87B undertakings? Mr Samuel—No, the 87Bs may indeed result from proceeding to litigation, but in most cases the 87Bs will have been at that lower tier; they will have been resolved prior to going to litigation. We are generally reluctant to proceed to an 87B after we have commenced litigation. Once litigation has started then, at best, if you are going to settle it, you will go to a consent order by the courts.

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But, if you put that in context, 39 cases going to litigation out of 53,500 complaints as a starting point, it indicates that the litigation is certainly the sharp point of our process; but you cannot necessarily measure our success in enforcement by the number of cases instituted each year. I think there are about 70-odd cases in process at the moment, if I am not mistaken, but in the context of the total number of complaints it is not the be-all and end-all of the way we operate. We are spending a fair bit of time with businesses, with corporations both big and small, and with small business groups, having them understand the way that we operate and the way that issues can be dealt with, particularly where a complaint arises. One of the things that we have been doing is encouraging businesses, where a complaint occurs with respect to their activities and where they have a culture of compliance within the organisation but obviously a problem has arisen, to, instead of taking the route of saying, ‘We deny the complaint and we will fight you through to the High Court,’ turn around and realise that a better way of doing things is to say: ‘Yes, look, we have a problem. Can we sort the problem out quickly, try to stop the consumer harm quickly, stop quickly the behaviour or processes that are occurring within our organisation that are causing the problem, and bring about some restitution of the consumer detriment as fast as possible.’ If we can bring about very quick processes like that, we will do so. On the other hand, our court proceedings are almost invariably moving through the quick track process. I mentioned Henry Kaye. That took us about three weeks, from the beginning of the investigation through to the institution of the proceedings. In a case in Queensland of an alleged Internet scam involving a company called Worldplay, I think we received notice of the complaint on a Monday and I think we instituted the proceedings and got some interim injunctions on the Friday of that week. Speed is of the essence to stop the consumer harm. I say speed is of the essence because there is very little satisfaction in getting a successful court victory and knowing that consumers have been ripped off in the process over many, many months or years. The one I often quote is the very successful court outcome that we got in the case of Danoz Direct and the sale of these Abtronic electronic muscle stimulant belts that you wrap around your waist and they are supposed to stimulate your stomach muscles, get rid of love handles and all those sort of things. Senator COONAN—Do you mean they don’t work? Mr Samuel—I am actually not sure; I will defer to wider experience on this, Senator. But what I can say to you is that we got a very successful court outcome there. The problem was that 90,000 of these units had been sold and $15 million had been paid by consumers to Danoz Direct in respect of the sale of those units. Those transactions are done and finished and there is no way that we can easily undo those transactions and restore consumers to the position that they were in. We get a successful court outcome and it makes for a great media release, but the outcome for consumers is, in our view, unsatisfactory. So speed now has to be of the essence, to stop these things occurring and to stop as quickly as we can the consumer rot and the consumer harm occurring. I mentioned, and it has been reported publicly, that we are spending a fair bit of time now concentrating on another side of our activities, and that is cartel activity, which is occurring in Australia. This encompasses price fixing and collusive tendering to governments, particularly

ECONOMICS E 34 Senate—Legislation Thursday, 19 February 2004 to local governments in respect of government contracts and other collusive arrangements. I am always asked how rife is cartel activity. The problem is that we will never know, because it thrives on secrecy. It is the secrecy that causes the difficulty because consumers do not know about it and regulators do not know about it. I can say to you that we currently have under investigation in excess of 30 cartels. I know there has been a reference in some newspapers to three to five. I should clarify that: those three to five relate to cartels that are fresh on the scene, that are currently being investigated, of which some have come through our recently announced leniency policy. That leniency policy is starting to bite, I think very effectively, now. It was a policy that we announced in the middle of last year whereby we said to those involved in cartels, ‘If you were not the instigator of the cartel, if you are the first whistleblower that comes forward to us and provides information about the cartel and you provide us with sufficient information to enable us to commence litigation against the other participants, there will be a guaranteed path of leniency through the process.’ That is starting to bite now as the whistleblowers are coming out and providing us with the information in both the international sense and in domestic price-fixing arrangements. A significant campaign this year will be in the prosecution of cartels, their exposure and the busting of those arrangements. I have described them as a cancer on the economy, and I think they are. They are a silent extortion of the Australian public. Whether they affect taxpayers through collusive tendering of government contracts or affect consumers directly, through price-fixing arrangements, in terms of what they buy in the marketplace, they deserve some very focused attention. Just to give an example of the sort of proportions, in the ABB Transmission case, which occurred in Queensland, I think to date we have extracted fines of the order of $26 million. I would like to be able think that as the case proceeds to finality there will be several million more dollars of fines and penalties that will be obtained in that area. It gives you an idea of the sorts of proportions that we are dealing with in one case alone. Let me conclude my comments—although ‘conclude’ is perhaps a bit premature—by referring to the issues of small business. One of the areas that we are focusing on this year is to work more closely with small business, to have them understand very clearly what the role of the ACCC is in protecting their interests under the Trade Practices Act and what the limitations of those protections are—in other words, what they should expect and what they should not expect from the ACCC. It is essential that all businesses in Australia understand that the act is built upon a foundation stone of vigorous lawful competition between small, big and medium sized businesses right across the board. Competition enables businesses that can innovate, be creative, provide choice, provide convenience and provide quality and lower prices to consumers to thrive. Vigorous lawful competition will enable that to occur. Anticompetitive conduct will do harm not only to consumers but to businesses that are attempting to behave and operate within the confines, the purview, of the trade practices law. Anticompetitive conduct ought to be stopped, but vigorous lawful competition ought to be promoted. Promotion of competition does not involve the protection of any sector of the economy from competition. It does not involve the protection of small or medium business or any individual big businesses from the normal processes of vigorous competition. Small business

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 35 has a range of protections available under the act. It has the fundamental protection that if it is an innovative, creative small business then it should be able to thrive in a vigorous, competitive economy; thus part IV of the act, which promotes vigorous competition between all businesses, has an inherent protection for small business. Small business also has, albeit in a limited form at the moment, the protection of section 46, and that is the subject of discussions in another committee that I know, Chair, you are involved in. Small business also has a very significant protection in the vertical supply relationships under part IVA of the act. There are a number of cases that we currently have before the courts in that area where the courts are showing—particularly with the operations of section 51AC—a tendency to deal with those sections and with that part of the act in a way that is designed to provide effective protection for smaller businesses in dealing with those with a more dominant bargaining power in a transactional sense and to protect them from unconscionable conduct. One of the other areas relates to collective negotiations. We are encouraging small business groups to advise their members that collective negotiations, with our authorisation, are one means that can enable them to rebalance the bargaining power, particularly when dealing with bigger business. I think it is an area where, at this point of time, there is perhaps less information than is appropriate out in the small business community as to the availability of collective negotiations as a tool for evening up that bargaining power. Codes of conduct are another area particularly attempting to deal with the small business/big business dispute area where legislators feel it is inappropriate to legislate to provide for the circumstances that arise between small and big business but where codes of conduct might be able to operate to their benefit. In this context, by way of final comment, I should mention our recent shopper docket report, as it is called. It is the examination into the petrol and grocery sectors. The specific technical issues of that report related to the shopper docket schemes, primarily those between Woolworths and Caltex, and Shell and Coles, and then in a broader sense between Metcash and IGA and its shopper docket incentive or reverse shopper dockets. There are over one hundred notifications we have of these sorts of schemes, and they are also related to some proposals by Coles Myer to acquire up to about 20 independent grocery stores over a period of time, so there could be an acquisitions issue. They are the technical aspects that we dealt with in the report. But what we chose to do in this report was to address a wider issue of the current, historical and future trends structure of the retail petroleum and retail grocery market in this country. What we found in the event was that there is a significant restructure that has been, and will continue to be occurring, in both the retail petroleum and the grocery market in this country. In the retail petroleum area we have seen substantial restructure occur over the past 30-odd years since the 1970s. In terms of the retail petroleum outlets, the most significant sign of that is that, back in the early 1970s, there were over 20,000 petrol retail outlets in this country and there are now something less than 8,000. You can see the influences that are being brought to bear in that area just by driving down the highways and seeing the gradual disappearance of some of the smaller retail petrol outlets—the six- or seven-pump outlets—in favour of those much larger outlets that have got 20 or 30 pumps and are attached to convenience stores of some 10,000 square feet in size, car washes and fast food outlets: in other words, one-stop

ECONOMICS E 36 Senate—Legislation Thursday, 19 February 2004 shops for providing a variety of services to deal with the high-volume traffic that occurs on high-volume highways and traffic routes. So the retail petroleum area is going through some changes. Those changes will be exacerbated by the new fuel standards which came into force on 1 January, which reduce significantly the availability of cheap imported fuel, which was, and has been, a prime source of fuel for mainly independent operators in terms of their discounting operations. It makes it more difficult for those operators to find cheaper fuel other than by buying it through the major refiners in Australia or potentially through some of the refiners in Singapore. So changes are occurring. Our conclusion was that the shopper docket schemes will have a very small impact on the restructure of the retail petroleum market in this country and will not have the sorts of impacts that some of the other factors that I have mentioned are currently causing to bring about. In the retail grocery market, we examined the issue of concentration in that market, the levels of concentration, the levels of competition that occur in that market, the issues of cross- subsidisation between the petrol outlets associated with Shell and Coles and Woolworths and Caltex, and some of the cross-subsidisation that is suggested that is occurring in the retail grocer area in relation to those schemes. We concluded that there was, and for the foreseeable future there will be, a highly competitive marketplace of retail groceries in this country. Despite the concentration that occurs with the two major supermarket chains of Coles and Woolworths, some of the smaller chains such as the Metcash group—through IGA—and Foodland are showing increasing market shares and increasing profits and appear to be, on current indications and their forecasts, not only surviving but actually thriving in the current competitive environment. There has been a long analysis that has been done of that—some of which appears in the public report that we issued; a lot of which is not there because it is confidential information provided to us by the parties on a confidential basis. It indicates that there are restructures occurring in this market as consumer demands require changes to occur. The fundamental issue for us is to ensure that what we have in the medium to long term is a very competitive marketplace, in both groceries and in retail petroleum. As far as we can see, in terms of our own prognosis and our own examination for the foreseeable future, we see those competitive markets maintaining their position and providing consumers with the choice, the quality and the prices that they demand. We therefore chose to permit the shopper docket schemes to continue. They are those associated not only with Shell and Coles and Woolworths and Caltex but also the other ones I mentioned: Metcash and IGA, and over 100 other notifications that we have received from other parties that are involved. I should mention the area of creeping acquisitions because it receives a lot of publicity. We pointed out that the issue of creeping acquisitions is not so much a legal issue as it is an economic one: the level of expansion of outlets by the major supermarkets through the process of acquisition is actually very, very small indeed relative to what I will call organic growth. The number of outlets that are actually acquired by these parties in one case was stated to be something less than five per cent of their total growth each year. In another case, it was stated to be so negligible that it barely measured in the statistics. So creeping acquisitions, although they are seen in one sense as being one of the prime causes of

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 37 increasing acquisitions, actually have a very small impact indeed on growth and growth in concentration on the part of the major supermarkets in this area. Organic growth is fundamentally the issue that is occurring there, and that raises all sorts of issues concerning the level of concentration that may or may not be appropriate between the two major supermarket chains—or the three major supermarket chains, if you include Metcash and IGA in that group. At what stage does the concentration get to a point where it is anticompetitive? The conclusion we reached is that, at this point of time and for the foreseeable future, we do not see concentration in those sectors reaching a level that would cause competition concerns. But that is a matter that has to be constantly monitored by us. If it gets to a point where we do see some competition concerns, we will need to take the appropriate action. I have talked at some length in relation to the small business area because I think it is an area that requires a degree of attention on our part during the coming 12 months to two years. We have to inform small business groups across the board about the sorts of issues that the ACCC can deal with and the sorts of issues that we cannot deal with, and should not be dealing with, in the context of maintaining the fundamental foundation stone of the Trade Practices Act, which is to promote vigorous lawful competition between businesses of all sizes. I will stop at that, Chair. CHAIR—Thanks, Mr Samuel. I have not read the reasons for the shopper docket authorisations—I think they were only published on 6 February. Can you tell committee what the ACCC’s conclusions were about the continuing role of independent fuel retailers in consequence of those authorisations? You are of course aware that this has been a much- agitated issue, particularly in the state that I represent—Queensland. What were your findings about the future role of the independents and the impact on them of the authorisations? Mr Samuel—There were two broad conclusions that we reached. The first is that the larger independent chains have been the most significant factor in driving petrol discounting in this country over recent years. Previous reports issued by the ACCC in this area, I think, have demonstrated over and over again that it is the larger independent chains as distinct from the smaller independent operators. Of course, there are a large number of smaller independent operators that operate through branded sites—that is, branded with the brand names of the major outlets. CHAIR—A few years ago when the ACCC approved the Ampol-Caltex merger, the ACCC was at pains to make that point. I hope there has not been a change in that policy or that position on behalf of the ACCC, evidenced by this most recent authorisation. Mr Samuel—No. In fact, it is reaffirmed in the notification decision that the larger independent chains have been the important drivers of petrol discounting. Having said that, the larger independent chains have been in part disappearing over recent years—for example, the disappearance of the Liberty group as it was acquired by Woolworths has taken one of the major drivers of price discounting out of the marketplace as it moved over into the Woolworths proprietorship. The other element that we indicated was that there are factors other than the shopper dockets that are going to impact upon the independent retailers much more significantly than

ECONOMICS E 38 Senate—Legislation Thursday, 19 February 2004 the shopper docket schemes. They were the factors I mentioned before. First of all, the smaller independent outlets—the small seven- or eight-pump type outlets—have been the subject of restructure over a period of time by the major refiner marketers and Woolworths and, more recently, Coles in this area. So we are seeing a move to fewer sites but larger sites associated with other convenience outlets and on much higher volume highways, rather than what we used to see, which was, for example, a small site on each of the four corners of an intersection. So that is occurring. The fuel standards will continue to limit to the ability of those independents to access cheap imported fuel, so they will be relying upon fuel that is available from the major refiner marketers in Australia and the possibility of imported fuel from Singapore that will meet the new MTB standards. We have already seen the impact of that in one or two states, particularly Western Australia, which for some time now has had the higher standards in place and thus limited the availability of fuel in that state to retailers from the sole refiner in the state—BP— which they have to supply the fuel. That has had an impact on the role of the independents in that state. If you have a chance to examine this document you will see that in our view the shopper docket schemes will not be the significant factor affecting the future of the independents in petrol retailing in this country. CHAIR—Do you consider that the larger independent chains will continue to have a role? Mr Samuel—I think that is going to depend on the availability of fuel from sources other than the major refiners, or the capacity of those larger independent chains to negotiate very good deals with the remaining refiners in Australia, which are the majors: BP, Mobil, Shell and Caltex. If they can negotiate those sorts of arrangements in terms of pricing for fuel at the wholesale levels then there is a continuing significant role for them in the marketplace. What I think is perhaps more relevant is the prospect, as the next one or two years pass, of the higher standard fuel being available from places outside Australia, in particular Singapore and other areas in South-East Asia. It is available from the gulf but to bring it from the gulf raises transport costs that ultimately make it somewhat uneconomic, in general terms. CHAIR—The other question I was going to ask you—and perhaps this is best directed to you, Mr Cassidy—was: since you were last before us, has the ACCC either commenced or resolved any of its section 46 cases? Mr Cassidy—By ‘since we were last before you’ do you mean— CHAIR—The additional estimates last November. Mr Cassidy—I think the answer is basically no. CHAIR—So no new ones have been begun— Mr Cassidy—Sorry, when you say resolved, in a sense we have discontinued the Qantas case, which— CHAIR—Have you discontinued any other than the Qantas case? Mr Cassidy—No, we have not. In terms of the arithmetic, which I think we have been through previously, at the time of the Boral decision we had 15 section 46 matters under investigation. We discontinued four of those as a result of the High Court’s Boral decision. We have discontinued another six but that is for reasons unrelated to Boral—the sorts of things

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 39 that happen in investigations, in terms of the evidence not being there and the legal advice on the basis of the evidence being that we just did not have a case with a reasonable prospect. CHAIR—So this time last year— Mr Cassidy—We have started another three since Boral, so at the present time we have eight section 46 matters under serious investigation. CHAIR—Thank you. Senator CONROY—Mr Samuel, I am conscious that you do have a deadline. I am hoping that it is slightly more flexible than 12 p.m., otherwise I have only a short period of time left. I appreciate we did start late, which was not your responsibility. Given the length and importance of your opening statement, I would not want to leave myself with no opportunity to ask you questions and so I am hoping you have a little bit of flexibility, though I appreciate that you are very busy. I want to start at the beginning. I would like to ask you some questions about the recent revamp of the ACCC’s web site. Given the tight budget of the ACCC, escalating legal costs and the fact that the organisation had an operating deficit of $10 million last year, I believe, what was the thinking behind revamping the web site? Mr Cassidy—This is a project we have had under way for a little while. It was partly to meet government requirements in relation to our web site. It was partly also proposed to respond to feedback we had had in relation our web site and to make it more interactive, so that it was easier for people to use our web site as a way of lodging complaints or inquiries with us. Senator CONROY—What was the cost of the revamp? Mr Cassidy—In total it was just under $1 million. Senator CONROY—Was it done in house or did you employ external consultants? Mr Cassidy—I will invite Helen Lu, who is the head of our corporate area, to answer that question for you. Ms Lu—We entered into a fixed price contract with a business, selected in the normal way, by surveying the possibilities and getting quotes. This project was undertaken over quite a long period of time—it took significantly longer, as these sort of projects always do, to complete. The primary driver for the revamp of our Internet site was the need to conform to government requirements for these sorts of sites to have the capacity for people to do business online—that is, the ability to do things like job applications and so on and, as Mr Cassidy has said, to lodge complaints on line. Senator CONROY—I note that the web site contained a video welcome from the chairman. Is that a requirement from the government? Ms Lu—No, but we thought that it would be an appropriate thing to do, having regard to the fact that we have a very popular and heavily visited web site. We do have logs, and we are aware of the amount of public contact we have through the web site. When it comes to it, you have to switch one off and switch the other on; and the new look is different, so we thought it would be appropriate to have a small video clip with our chairman welcoming people to the

ECONOMICS E 40 Senate—Legislation Thursday, 19 February 2004 new site. That video clip was made in house and installed in house at no significant cost whatsoever. Senator CONROY—It seems to be missing at the moment. What has happened? Is there something I do not know about, Mr Samuel? Mr Samuel—I did not instigate the video clip and I simply provided five minutes contribution to— Senator CONROY—They have cut you! I do not know what it all means but they seem to have dumped you from the web site, Mr Samuel. Are you making an appearance, Mr Cassidy? Mr Cassidy—Without wishing to give any offence to our chairman, we thought that the welcoming message from him probably— Senator CONROY—Had worn out its welcome? Mr Cassidy—Yes, I suppose you could put it that way. We only had it up for I think about six or eight weeks following the launch of our new web site. Senator CONROY—You did mention it was a heavily visited site. How many hits have you had? Ms Lu—I cannot tell you that. I could find out and let you know, if you wish. Senator CONROY—You just indicated it was a lot, so hopefully— Mr Cassidy—Our web site, both before the rebuilding of it and currently— Senator CONROY—And, with Mr Samuel’s video on it, was there a huge increase in hits? Mr Cassidy—It is a very frequently visited web site. Whether the chairman’s opening remarks boosted that or not, I am not sure. Senator CONROY—It could be interesting to test: we will have a before, during and after. It is going to be easy to assess Mr Samuel’s impact. Mr Cassidy—In all seriousness, we have also made a few other changes to what we are doing with the web site, including our Competing Fairly Forums, which we have discussed before, which are part of our small business activities; our broadcasts into regional Australia. We are now video-streaming those on our web site so— Senator CONROY—I was going to ask you whether there were going to be any more videos, such as Mr Cassidy waving? Are there any other plans? Mr Cassidy—No, we are not planning to use our web site in an ongoing sense for welcoming messages and so forth. We will continue with the video-streaming of our Competing Fairly Forums because they are proving popular. We had the most recent one, which was on supply chain issues in the grocery and fresh food areas, there and we also had the previous one, which was a hypothetical that we did with Geoffrey Robertson while he was in Australia late last year. They are both streamed on our web site. Senator CONROY—So the media player function was already there? You indicated a minute ago that you had added it at minimal cost.

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Ms Lu—Yes, absolutely. Senator CONROY—And use of the media player function will be ongoing? Ms Lu—It can be, yes, when appropriate and necessary. Senator CONROY—Do you have any plans? Are there some very attractive faces there we can advertise? A bit of practice for Australian Idol? Mr Cassidy—No, we do not have any further plans in that regard. Ms Lu—No specific plans. Senator CONROY—You are being shy, Mr Cassidy. Mr Samuel—The Competing Fairly Forum will certainly go there. Senator CONROY—Mr Samuel, I wanted to ask you about an article I read in the media and, in particular, about your relations with the media. You would be aware that there was a fair amount of comment about your predecessor’s media role. There were lots of comments in all directions about what people thought of it. Do you generally make yourself available to the press if they are seeking comment on a particular matter? How does it work? Mr Samuel—As you are probably aware, our media relations are coordinated through Lin Enright in the office, but I make myself freely available to the media to comment on issues, subject to certain constraints or rules that are firmly in place. The first is to say that consumers, the Australian public, and Australian businesses have a right to know, within certain constraints, what we are doing, what is happening, what the ACCC’s activities are and what the purposes of the activities are. That is for the purposes of informing the Australian public and Australian businesses of their rights and responsibilities under the Trade Practices Act. One of the constraints is that confidentiality must be maintained where material has been provided to us on a confidential basis and where there are issues that are currently under investigation or otherwise being dealt with where it is inappropriate for the public to be made aware of issues that are before us at a point in time. In that context we will not talk publicly— or communicate by innuendo, rumour or background briefing—about the specifics of any investigation that we are currently undertaking, nor will we provide any elaboration on issues that are currently before the courts. We take the view that, once court proceedings have been instituted against a party, it is appropriate, in a very factual way, to explain the existence of those court proceedings to reveal no more than would be available to any member of the media looking at the court record of the statement of claims. We provide no further comment on court proceedings at the point in time that those proceedings have been instituted, and we will not comment upon those proceedings during the course of the proceedings themselves. We will not be involved in the inappropriate tarnishing of business reputations by background briefing or innuendo. Senator CONROY—You are not suggesting that that has been happening, are you? Mr Samuel—No, I am just setting out the rules that are in place. As I have said on many occasions, good business reputations will be tarnished by bad business behaviour; they cannot be tarnished by bad behaviour on the part of the ACCC. That will not be permitted to occur.

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The other area where we have significant restraints on our public commentary through the media is in relation to policy matters. It has long been my view—and it is the commission’s view—that issues relating to public policy and, in particular, changes in legislation are matters that ought to be dealt with through the appropriate processes of parliamentary committees and/or dealing with government. They ought not be the subject of public comment by the regulator through the media. We are there to administer the law. It is parliament’s role to establish the law and give us our mandate to administer. Therefore, you will find that our comments in respect of public policy issues and changes to legislation are now constrained and are subject to whatever is placed on the public record through the appropriate policy committees of parliament. I think the best example of that is our recent submission to the Senate Economic References Committee dealing with the issues of small businesses under the Trade Practices Act. Senator CONROY—I will change the subject briefly. You would have noted this week, despite the fact that the committee has not even produced its report, that the chairman of the Business Council reiterated his position that they would rather have no change via Dawson than risk any change to section 46. I think I described that as a huge dummy spit when he first made that statement. He keeps trying to claim, I think from the article I have here, that the High Court is interpreting the section of the act the way parliament intended. Clearly you do not agree with that. Mr Samuel—Absolutely. We fundamentally disagree with that and said so in our submissions to the Senate Economic References Committee. There is some confusion here as to the role of the High Court. There are some in the legal profession that suggest that the High Court might have got it wrong. I do not think it is appropriate for any of us to suggest that six judges of the High Court have got it wrong. Senator CONROY—I will barrack for the Kirby position. Mr Samuel—Our view is that they may have interpreted the law correctly, but what they have indicated is that, if parliament intended the law to state what, in 1986, they had indicated it would state, they did not achieve it with the appropriate drafting and the law therefore needs redrafting. Senator CONROY—Mr Morgan’s comments seem a little over the top. Mr Samuel—I think for some time now the ACCC have been at odds with the Business Council of Australia and perhaps with the Law Council of Australia—that is, the major legal firms that tend to represent larger business in this country. We have been at odds with them in our views on the appropriate way in which section 46 ought to be dealt with and ought to be redrafted. That is our role—to put to parliament what we think is appropriate in terms of the public interest and the way we think the law ought to be expressed, having regard to what parliament expressed its intention to be back in 1986. Senator CONROY—The heading on the press release says, ‘Consumers will lose from trade practices changes’. Is that a fair call? Do you think the Business Council is right? Mr Samuel—It is a bit premature at this stage for anyone to indicate the results of changes when we do not know what the changes are going to be, we do not know what the committee is going to recommend and we do not know what the government might do with respect to the

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 43 changes. If the committee were of a mind to recommend changes, and this will sound a little bit arrogant, I am afraid, along the lines of those that— Senator CONROY—That the commission put forward. Mr Samuel—the commission’s submission recommended then I think it would be very strange indeed if we were to even suggest a scintilla of acceptance of the view that consumers would be harmed by that. Our view is that the changes we have recommended are of a clarification nature and are designed to evidence the intention of parliament back in 1986-87. Given that parliament then said that this is what they thought the act ought to say, given that businesses—big, small and medium—have ever since recognised that that is what the act ought to say and given that the High Court has most recently said that the act does not say that, then you would have to say that the section needs a redraft. Given also that the broad purpose of part IV of the act is to protect a competitive business environment for large, medium and small business, in the interest of consumer welfare, it would be very difficult to show that those sorts of changes were designed to harm consumers. Mr Cassidy—The heading really stems from the contention in the press release that the changes being proposed to section 46 strike at the heart of competition and in particular would prevent companies engaging in what the press release refers to as ‘price wars’. I do not know that I am necessarily across every change that is being suggested to section 46— Senator CONROY—I do not know anyone who has proposed that. Mr Cassidy—I would have to say, in terms of the changes which we have proposed, I think— Senator CONROY—Even in Senator Brandis’s wilder moments I do not think he has gone that far. Mr Cassidy—In terms of the changes we have proposed, I think that statement is nonsense. Senator CONROY—His proposition that consumers can be hurt seems extraordinary. If you were sitting there as a consumer in consumer land and you heard the President of the Business Council say, ‘I am interested in looking after consumers,’ and you heard Graeme Samuel or Allan Fels from the ACCC say, ‘Well, actually we think this is what will benefit the consumers,’ I know who I would believe. It is a bit of a brave call, I would have thought. Mr Samuel—Thank you for the vote of confidence, Senator. Senator CONROY—I am sure you will find that that is the case in voter land as well. Mr Cassidy—I think it is an important point that the changes that we have put to the committee in no way prevent companies legitimately competing—legitimately entering into what the press release refers to as ‘price wars’. The whole thrust of the section would still be that there needs to be behaviour based on market power that has the purpose of harming or eliminating a competitor or preventing a competitor from entering the market. I think the heading of the press release is based on a premise which is wrong. Senator CONROY—I dare not go too much further on this because I have the chair of the committee sitting next to me. We will be producing the report soon and I do not draw her ire

ECONOMICS E 44 Senate—Legislation Thursday, 19 February 2004 by being seen to canvass what the report might or might not have in it. Given the view you have that the section is not working at the moment and does need change and, given the lack of success that you have had due to court decisions in this area, would it be fair to say that consumers are being harmed by a no change position? Mr Samuel—Our view is that the section, as it currently operates, does not operate to prevent unlawful anticompetitive conduct in the context of misuse of market power. To the extent that that results in harm to consumers, because that is our fundamental thesis—that anticompetitive conduct by the misuse of market power causes harm to consumers—then the section as it currently operates is not operating to the consumer benefit. Senator CONROY—Thank you. I want to go back to relationships with the press. You may recall that last August you gave an interview to the Australian newspaper concerning how you handle the media. You said that you had a list of 50 journalists and that you ranked them in terms of how trustworthy they were. You are quoted as saying: I’ve got a list ... I’ve drawn it up over the years. I rate journalists as: totally trusted, cautiously trusted and not trusted at all. There are shades of grey. The story said that you expected the media to stick to two rules—when agreed that a discussion was off the record, it does not get reported; and never wilfully to distort a story— and if either of those rules are broken access is denied. Have you yet to deny access to any journalists since you have become chairman? Mr Samuel—No, I have not. Let me say, by the way, that list of 50 includes— Senator CONROY—I was going to come to that. I am hoping that you might illuminate the committee as to which are the most trusted. Let me hazard a guess: Stephen Bartholomeusz can be ranked at No. 1. Then we can start at No. 2 and work our way down. Mr Samuel—Yes. It just shows what can happen when you use some fairly loose descriptions of modus operandi in the media. Senator CONROY—Have they wilfully distorted you? Mr Samuel—No, they have not wilfully distorted me; it is a reasonable representation of what I said. But I should mention that many of those in the media who are on that list of 50 relate to my former life in the football world and— Senator CONROY—Who is at No. 49 and 50? Come on, Mr Samuel, name names. Mr Samuel—I do not rank them in the order of one through to 50. They would be the more recent acquisitions in this area. Senator, you, better than me, would be aware that the vast bulk of those in the media with whom you deal are very professional and very responsible. You can deal with them on a very trusting basis, understanding the two fundamental rules—and there was a third rule I indicated there, relating to those who are interviewed by the media, that you never lie to the media. Senator CONROY—You made that point very clear in the article. Mr Samuel—You have to be absolutely frank. If you do not want to make a comment about something, then the two words that gain the least publicity are ‘no comment.’ In terms of dealing with the media, the vast bulk of those with whom we deal in the ACCC and with

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 45 whom I deal personally are absolutely to be trusted and are people who behave very professionally. But every now and then there will be a— Senator CONROY—Who is on the black list—come on? Mr Samuel—I do not think it would be appropriate to mention that. Senator CONROY—Come on, you are a public official—name names. Who is on your black list? I note that John Garnaut from the Sydney Morning Herald is sitting in the gallery behind us. Is he on your black list? Mr Samuel—No, he is eminently professional and to be trusted. Senator CONROY—The kiss of death, Mr Garnaut. Mr Samuel—Senator, I think you could probably name a black list. Senator CONROY—Mr Garnaut, you just shot up the list of 50; you are at about No. 3 now. Mr Samuel—You could probably name your black list a lot quicker than I could. There are some in the media with whom you have to exercise some caution and that caution is required because we are a very public institution. Our views, the views that I express as the face of the institution, are read by many consumers and by many businesses. If your views are misrepresented, that causes the position of this public institution, which is so important to public life in Australia for both consumers and businesses, to be misrepresented. That makes life difficult for us in terms of administering the law, but it also causes a great deal of difficulty for consumers and businesses if they do not understand the way we are administering law. The only way we can correct that is by communications through letters to the editor and the like, but they do not get the sort of publicity and the sort of attention that, for example, a headline might obtain on the front page of a newspaper. We have to say to the media, ‘We have a responsibility, as you do as the pipe—the message bearer—to inform the public and to inform businesses of their rights and responsibilities under the act. We have to do our very best to ensure that you are as informed as you can possibly be and as we can assist you to be, in order to represent the views that we have and the processes that we adopt in administering the law as fairly and responsibly as possible.’ But if that does not happen and it happens through a deliberate distortion, then that can cause us some very grave difficulties. Those difficulties mean that we then have to go into a major damage control or repair process in order that businesses and consumers will not continue to be misled. Senator CONROY—Do you think that journalists could interpret your comments as a warning that, if they criticise you, they might find their ability to report the work of the ACCC severely restricted? Mr Samuel—I doubt that there are any journalists in Australia that would be, in any sense, intimidated by the reference to those two rules, which they know are the rules under which all professional journalists operate. Senator CONROY—I am not talking about your ranking system— Mr Samuel—No, the ranking system is— Senator CONROY—totally trusted, cautiously trusted, and not trusted at all.

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Mr Samuel—You will see that that ranking, which is a very loose ranking, relates to the— Senator CONROY—Terry McCrann is at No. 2; Bartholomeusz is— Mr Samuel—No, they relate to the rules that I have set out there. I doubt that there is any professional— Senator CONROY—They are not AFL writers, are they? Mr Samuel—Terry McCrann might say so if he was writing about the Essendon Football Club— Senator CONROY—Terry’s position on football is just not worth listening to. Mr Samuel—in much the same way that you would regard yourself an expert on the Collingwood Football Club. Every professional journalist in Australia would respect those two rules as being a fundamental way of operating with people like you and us in public life, and that is the process of trust and relationship that occurs between people in public life, be they politicians or regulators or others, and the way that we can operate on a proper basis. I think, therefore, every professional journalist would respect the fact that if I lie to a journalist I should not be trusted. If they deliberately distort a story then they should not be trusted. If they are involved in reporting something that is off the record, when the fundamental rules of ‘off the record’ are well known to you, me and everyone else who operates with the media, then they should not be trusted. They are the rules of a normal relationship between people in public life and the media. Senator CONROY—It would concern me that, if there was a black list as such— Mr Samuel—No, there is no black list. Senator CONROY—that would undermine the accountability of the ACCC. Mr Samuel—I can absolutely assure you that there is no black list. It is perhaps appropriate to note a comment that was made at a dinner I attended two nights ago. Someone said to me that while there was some comment about the profile of Allan Fels, he must be smarting at the moment, noting that my profile seems to be even higher than his, which is not something that I have designed to— Senator CONROY—That is a very big call. Mr Samuel—Yes, it is a big call. It is certainly not something that I— Senator CONROY—We will be able to check on the web site: Allan’s hits versus Graeme’s hits on the web site. We will be able to verify that for you soon. We are getting that information. Mr Samuel—We tried to rectify that with the welcoming video on our own web site. Senator CONROY—Yes, absolutely. I cannot believe Allan did not think of that. It is very good. Mr Samuel—It was just to compensate for the lower profile that I am trying to maintain in the media. Senator CONROY—Moving on to an article that was in the Financial Review recently, saying that you had been engaged in discussions with some CEOs about troublemakers in

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 47 their organisation, could you just explain what you are trying to do in these discussions and how they assist the commission? Mr Samuel—There are not many: I think I indicated there are two or three organisations involved at this point in time. Where we receive information that an organisation has a rogue operator within it—someone about whom the CEO may not even be aware; he may not have any information, but there is a rogue operator within the organisation— Senator CONROY—I understand if a person is actually guilty or potentially guilty of some misbehaviour, but you would not be talking to them; you would presumably be dealing with the legal counsel of the firm. Or do you reach down into the organisation and pick the supply chain manager? I thought the people you are dealing with, other than the CEOs, would most likely be the legal officers. Mr Samuel—No, in many cases we will receive complaints about a particular manager of an organisation or a particular operator—a trader or someone within the organisation—in relation to which there may be some serious complaints. One of the first processes of that is to deal with the complaint, going through the normal processes of dealing with perhaps the legal department or whatever it might be. But if we detect that there is a problem within the organisation that perhaps the CEO may not be aware of, then— Senator CONROY—But you identified that these were the people who have to deal with you. The sorts of persons you have just identified there are not the people who regularly deal with the ACCC. That is what you said—that it is your choice as to who you appoint to deal with you. This is the regular liaison point person that you have identified, that you have targeted. Mr Samuel—Let me perhaps draw a distinction between two different cases. There may be organisations where the parties who deal with us on a day-by-day basis have an approach which reflects confrontation with the ACCC, a reflection of the view that the ACCC is a necessary evil that is going to do damage to business because of the way the ACCC operates and that the trade practices laws really are not conducive to proper business behaviour. I am talking very loosely. If we detect that in an organisation there is an individual who has that approach and it is the prime party with whom we are dealing and that that is the party, for example, who is in charge of the compliance strategy of the organisation, then you know you have a cultural problem. If we can indicate to a CEO that that individual may be causing a fair degree of noncompliance and a noncompliance culture within the organisation that is going to be bring the organisation to grief in the context of the Trade Practices Act and the ACCC, then I would not have any hesitation in saying to the CEO that that is the case and giving them advice—and it is no more than advice. There are other cases where complaints will come to us that will show that there is a systemic problem, a process problem within an organisation, but that systemic or process problem can be honed back to a single individual or one or two individuals. In large organisations particularly, CEOs may not be aware of those individuals. In a recent case we got information, checked the information out—we checked it through a number of sources— and realised there was a problem. I spoke to the CEO. The CEO came back within a very short period of time and said: ‘I wasn’t aware of the problem. The problem has now been

ECONOMICS E 48 Senate—Legislation Thursday, 19 February 2004 fixed. Thank you very much for the advice.’ It is simply to try and solve problems very quickly if we can do it by that process. By the way, that does not necessarily mean that the organisation will not be subject to other enforcement processes; but it is important to stop the rot occurring very quickly, and if we can do that by a quick phone call first then we will do so. Senator CONROY—Do you think there are some risks in this approach? For example, if a CEO moves someone on following your conversation are you at risk of being subject to a defamation action? Mr Samuel—That has been raised with me in a— Senator CONROY—Have you taken legal advice on this? Mr Samuel—No. I should say to you that the approach that is adopted has two elements to it that I think are important. The first is that we need to satisfy ourselves beyond any reasonable doubt beforehand that this is an issue and that this particular individual—or whatever may be the case—is a difficulty. That deals with the rogue trader, the rogue operator or the rogue manager circumstance. So we take a fair degree of caution in dealing with that before we take any steps. In terms of the relationship issue, that is a bit different because all we do there is we will say to a CEO, ‘We are dealing with X, and you ought to be aware that X’s approach is a difficult approach. It is an approach that tends to be confrontationist; it may be an approach that is not conducive to a proper compliance culture.’ We are not alleging— Senator CONROY—Truth is not a defence in some states. Mr Samuel—I have to say to you— Senator CONROY—In New South Wales for a start, quite seriously, truth is not a defence. What you are saying may be true. Mr Samuel—If we move off the rogue trader operator to the person who has an approach that is confrontational, I think we are very careful to say to CEOs, ‘We are not suggesting any wrongdoing on the part of that individual at all; all we are saying is that you might want to watch the compliance processes you have in this organisation to see whether there is not a better way of doing it.’ Our compliance strategy branch will then work with organisations to look at compliance processes and compliance systems and will indicate to CEOs that there are two or three ways of dealing with these things and that perhaps the way it is being dealt with at the moment is not appropriate. Senator CONROY—But if somebody who has been dealing with your organisation gets a knock on the door or called in to see their CEO and is told, ‘Thanks very much; we’re aware you’ve been causing problems: you’ve got up Graeme Samuel’s nose and the ACCC’s nose in the way you’ve been treating them, and we’re moving on,’ I would be straightaway looking for some recompense from you, Mr Samuel. Mr Samuel—As I have indicated before, one of the issues that we are very cautious about is improperly tarnishing or damaging individuals’ or businesses’ reputations. Senator CONROY—You are certainly going out of your way to avoid tarnishing the businesses. It is just a few individuals whom you have trashed all over the front page of the Financial Review. You have not named anybody, but Mr X has been tarnished fairly heavily on the front page.

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Mr Antich—One of the issues— Senator CONROY—Is it you they upset? Mr Antich—Not to my knowledge. Senator CONROY—Have you passed any names on to Mr Samuel? Mr Antich—The issue you are addressing is no different from any other complaint the commission gets. If the commission gets a complaint or an allegation made— Senator CONROY—Mr Samuel has not identified that the people he is talking about are the people you have received complaints about. I am not sure if you saw the article—you might have seen it a while ago—but I am happy to read the entire thing to you. This is targeted at compliance. Mr Antich—Yes, it is. Senator CONROY—This is not about someone you have received a complaint about—the ACCC are complaining; they are not saying ‘We have received a complaint.’ Mr Antich—It is in response to a complaint that we get that we will act on it. We will act on it in a number of ways. The normal process is not to take it at face value and accept it as correct. We normally put it, as a case of natural justice and as a part of our normal job, to the person who has been complained about and say, ‘What is your view on this issue?’ That can either be formally put to the person or it can be put to the company through various channels. Which channel we choose is a matter for us. I do not think that falls in the normal realms of what you are suggesting. All we are doing is investigating a complaint and putting the issue to the company concerned. It can be a systemic issue; it can be a general issue. Senator CONROY—Let me help you. I have the quote here—I am presuming that you have not been distorted—I am working on that basis. I have not checked with Ms O’Loughlin if she is on the black list today. I am assuming that she is not. It says: In two or three companies I have identified troublemakers. Mr Antich, are you aware of any troublemakers that Mr Samuel has identified? Mr Antich—Yes, in the sense that these are the sorts of issues that are discussed within the commission as to the appropriate response to deal with it. Senator CONROY—It goes on to quote Mr Samuel as saying: ‘Look, it’s your choice who you hire and fire; your choice as to who you appoint to deal with us. But I’m saying to you that X is a problem; X doesn’t understand the culture of compliance; X believes [the ACCC] is a waste of time; X believes we are a group that doesn’t understand how business works’. This is not the line manager down the scale; this is the compliance officer we are talking about. Mr Antich—But you can also be a line manager responsible for compliance issues. Senator CONROY—Yes, you can be. But that is certainly not the implication that is given. It goes on at some length to talk about the story. So, we have a hit list of journalists, we have a hit list of officers. Do you have a hit list of politicians? Are any of us on your black list?

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Mr Cassidy—As Mr Antich has tried to explain, this is not all that unusual in terms of the way we operate. Senator CONROY—Is reading about it on the front page of the Financial Review? Mr Cassidy—I had occasion recently, obviously I will not specify the companies, to write to an overseas parent company basically saying that we had had a number of complaints and a number of investigations relating to a particular manager that they had here in Australia and that it might be in the company’s interest to seriously look at the behaviour of that manager. So (a) it is not something that is all that unusual in terms of the way we operate and (b) it is not something that is purely on the chairman’s duty statement and no-one else’s. Senator CONROY—I am just quoting Mr Samuel: ‘Look, it’s your choice who you hire and fire.’ That is a fairly subtle message! Mr Cassidy—I am afraid that is a real issue some companies have to confront. Senator CONROY—Senator Coonan, do you write to anyone and suggest hiring and firing people? Senator Coonan—I do not think that is something that is an appropriate subject for estimates. Senator CONROY—I hope that you have not done that. I am sure you have not. Mr Cassidy—In the same vein, you may recall that one of the Dawson committee recommendations is that there should be a remedy for the courts that certain people can be debarred from holding office within a company. Senator CONROY—Yes, but there is a legal process there. This is a bit nudge nudge, wink wink, Mr Samuel has been on the phone: ‘It’s your choice who you hire and fire and deal with us.’ There is a process involved in what you are describing. People have legal recourse, if it is natural justice issues— Mr Cassidy—I must say that some of us would perhaps be a bit blunter than that depending on the particular background to the investigation. Senator CONROY—It is possible that a perception could arise from seeing a front-page story like this that the best way to have a fair go is to have a compliance officer with the ACCC. Mr Samuel—No. What I think it might indicate—and it pays to indicate this in virtually every public speech I have given since taking on this role—is that the best way to operate in the business community today is to have a compliance strategy in place that understands compliance with the Trade Practices Act. Senator CONROY—That would always be helpful. No doubt that would be right, Mr Samuel. Are you intending to continue giving the CEOs a ring and letting them know? Mr Samuel—If there is any appropriate process where we can bring about compliance with the act—whether it ranges through education information, establishing compliance strategies or compliance culture, or taking prosecutorial actions—then we will use that process, because our role is to bring about enforcement and compliance with the act itself in the interests of the Australian consumer.

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Senator CONROY—Thank you for that. I just want to move onto shopper dockets, which you did mention earlier. I think possibly you had a brief chat with the chair about it. I would like to ask you about the commission’s recent report on shopper docket petrol discounts increasing competition. The commission concluded that there are substantial benefits for consumers from shopper docket discounts. In order to reach this conclusion, wouldn’t you have to be satisfied that the supermarket chains are not cross-subsidising—that is, that consumers are not paying higher grocery prices to pay for cheap fuel? Mr Samuel—In fact, we indicated in our report that cross-subsidisation may be occurring, although I think it has become clear that what is perhaps being affected is more the margins than the prices, so that it may be margins that are being affected at the grocery level rather than necessarily the prices to consumers. But the important thing is to ensure that both your retail petroleum market and your retail grocery market are highly competitive, because that then ensures that consumers of products sold in both markets are obtaining the best results of competition in terms of quality, prices, convenience and information to be able to make their choice. We concluded that both markets were highly competitive and, as a result, consumers were getting the benefits of competition in both markets, whether or not there was cross- subsidisation. Cross-subsidisation, as you would be aware, occurs in many business organisations between products and between branches and divisions of those organisations. But the important thing is to ensure that you do not have a circumstance where any particular segment of a market is so anticompetitive that artificially high prices can be passed to consumers as part of a cross-subsidisation process where consumers suffer, to their detriment. Senator CONROY—You mentioned that margins might have been affected. Is that suggesting that because of the discount on petrol the margins in the retail supermarket may be higher than they were previously? Mr Samuel—No, it is just suggesting that if you have got a market that involves both petrol discounting and grocery discounting, and you have got strong competition operating in both markets, then it is almost certain that you will not see prices increase; what you will see is margins decrease. Then those margin decreases would be offset by cost-cutting, which is part of the efficiency process. Senator CONROY—Does the commission know if fuel is being sold below cost on a regular basis by fuel outlets tied to Coles and Woolworths? Mr Dimasi—We monitor the price of fuel and we regularly see variation in the price of fuel. Depending on the cycle and depending on how you measure it, you can see a negative margin in the price of fuel, which we have seen over a number of years of monitoring. Often in the cycle you can certainly suggest that there is a negative margin, but I guess whether any individual company is selling below cost— Senator CONROY—Does that concern you? We are talking about Coles and Woolworths petrol outlets here, because that is where the issues of retail supermarkets and petrol intersect. So far we are not sure—it may be occurring that there are cross-subsidies between the retail and the petrol. I think you have acknowledged that selling below cost does happen.

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Mr Dimasi—No, what I am saying is that over a number of years of monitoring we have seen a significant degree of movement in the price of petrol. That is affected by a range of factors—the price of crude, the exchange rate, the cycle of discounts— Senator CONROY—I appreciate the generality of your answer. What I asked you was: do you know if fuel is being sold below cost by fuel outlets tied to Coles and Woolworths? Mr Dimasi—No, we do not. Senator CONROY—You do not know? Would it concern you if they were? Mr Cassidy—There is a high probability that that is occurring on at least some occasions. Part of what Mr Dimasi was saying is that, particularly in the capital cities, we observe a fairly regular weekly cycle. At the low points in that cycle for prices it is quite common for petrol to be sold below cost, not only by Caltex and Shell stations involved in the shopper docket arrangements but indeed by service stations more generally. So there are points almost on a weekly basis where petrol is being sold below cost. But, as I said, that would not be limited to the service stations involved in shopper dockets. Senator CONROY—But you do not actually know what the factual situation is. You are surmising that that is the case. Mr Samuel—No, we have confidential information that— Senator CONROY—I have just asked Mr Dimasi if he knew, and he said no. Mr Samuel—I can elaborate. We have confidential information that indicates to us two or three things. The first is that the shopper docket schemes are not resulting in losses occurring in the petrol retailing element of the relationships that are established. The second is that our petrol price monitoring makes it clear, as Mr Cassidy has indicated, that, at points of time during the weekly price cycle of petrol, petrol is often being sold across the board at low cost. There are other times during the weekly cycle when it is being sold well above cost. It is the averaging that occurs through the week. Senator CONROY—I appreciate the point that you are making, but that does not answer the questions I have asked. My questions revolve around whether or not you know if there is cross-subsidising. Your answer is that there may be—in other words, you do not know. I have asked whether or not you know if Coles and Woolies are selling below cost on a regular basis. Your answer is that you do not know. And you have cleared everybody of any competitive issues in the retail sector. Mr Samuel—Yes. The issues you have raised of cross-subsidies and below-cost selling are not necessarily indicators of anticompetitive conduct. Anticompetitive conduct or misuse of market power would occur where you had below-cost selling that was clearly predatory in nature. There is, on our investigations, no evidence that that is occurring. Cross-subsidisation is not a matter of anticompetitive conduct, particularly where you can demonstrate that the markets concerned are operating in a very competitive fashion. All our investigations, as the shopper docket reports will indicate to you, show that the retail grocery and retail petroleum markets are very competitive markets. Senator CONROY—Selling below cost does not necessarily mean predatory pricing. We have had a discussion about that before, and we have discussed the High Court’s view and so

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 53 on. At what point is it crossing the line? Help me here. Other than a Boral style situation where they actually wrote that their intention was to destroy a competitor, what evidence would you need? What would satisfy your interests? So that we can be clear—we are not going to impugn Coles or Woolies; we are not suggesting anything here—what would be the evidence that would make you say, ‘Ooh, we think predatory pricing is occurring?’ Mr Cassidy—Predatory pricing is pricing below cost which is targeted at a particular competitor. The sort of situation that we have looked at several times in retail petrol is where, say, an independent claims that the branded sites of the majors nearby are deliberately underpricing him in order to force him out of the particular area in which he operates. We have undertaken several of those sorts of investigations, where basically we look at pricing behaviour over a period of time and we look at the cost information for each of the companies involved. That is the sort of thing that we are looking for—in other words, targeted behaviour rather than— Senator CONROY—So as long as it is universal—that is, they offer 4c everywhere, at every site—by definition it could not be targeted? Mr Cassidy—The more widespread very competitive pricing behaviour is, the more you would struggle to say that it is predatory conduct. Senator CONROY—The Service Station Association have said that 1,500 independent petrol stations will disappear in the next five years because of the introduction of these schemes. Is it the ACCC’s view that further rationalisation of the industry is inevitable? Mr Cassidy—As the chairman said earlier, we have come to the view that there is a long term rationalisation process going on in petrol retailing. It has happened in overseas countries as well as in Australia, and we do not see anything to suggest that that trend is not going to continue. Indeed, we can see some factors—and we believe shopper dockets are a fairly minor one—which will probably, if anything, tend to accelerate that trend. Senator CONROY—Does the ACCC have a view on what effect the departure of 1,500 independent operators would have on competition in the sector? Mr Cassidy—As the chairman said earlier, you distinguish amongst the independents between what you might call the independent chains and then the stand-alone independents. Much of the rationalisation in the industry in recent years has been by the stand-alone independents, and our monitoring of petrol prices over a period of time has shown that they tend to be price followers rather than price setters. In other words, they are not the real competitive drive in the market. Those stand-alone independents have been disappearing and, we expect, will probably continue to struggle. As long as the independent chains remain competitive—and we think they probably will simply because of buying power and their size and so forth—we see them as continuing to be a competitive element. Senator CONROY—So there is not much future, in the ACCC’s view, for the one-off family-owned service station? So John Howard’s dad has no future? Mr Cassidy—It is a situation which we believe is unfortunate on various counts but we think the structure of the industry and what is happening in the industry, as well as some external factors, are moving against those particular types of service stations.

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Senator CONROY—I think that was a yes. Mr Cassidy—It was my way of saying yes. Senator CONROY—You do not think there is any impact at all from losing all the one-off stand-alones? Mr Cassidy—There could well be some, particularly when you get into some of the more regional areas. That said, we are a bit encouraged by what we are seeing at the moment in terms of the response, including from the stand-alones, to Woolworths and Coles shopper docket arrangements in that in addition to their two notifications under the third-line forcing provisions we have about a hundred other notifications. A number of those are in country towns and regional centres, where the local service stations—including, say, the local independent—have entered into shopper docket type arrangements with the local supermarket. So there is a competitive response that is occurring there. Senator CONROY—So a knock-on effect is taking place. Mr Cassidy—I suppose we have a certain degree of optimism, particularly out in the regional markets, that these sorts of mini shopper docket arrangements, which are springing up at quite a rate, will help the stand-alone independents to survive. But, as I say, I think there are forces afoot in the petrol retailing industry that unfortunately do make life difficult for the stand-alone independents. Senator CONROY—Last November there was considerable controversy surrounding the so-called Caltex FUD memo. The memo written by Caltex executives stated that the company should use ‘fear, uncertainty and doubt’ to destabilise franchisees ahead of negotiations about sites affected by the joint venture to sell petrol with Woolworths. Are you investigating that matter? Mr Samuel—Yes, we are, Senator, in the context of, particularly, the suggestion that there may be some unconscionable conduct involved. Yes, that is being investigated. Senator CONROY—Are you proposing to take action? Mr Cassidy—We have not reached that point yet. We are still pursuing with Caltex just exactly what has happened to individual franchisees, particularly franchisees who have entered into new franchise arrangements during the period when the shopper docket arrangements between Caltex and Woolworths were being negotiated. That stage is an ongoing process and we have not reached any point in terms of deciding whether litigation or other action is appropriate. Senator CONROY—It looks a pretty good case on the surface, though. Mr Cassidy—Well, these things often look pretty good on the surface but, as I have said on previous occasions in relation to other issues, at the end of the day we have got to be able to go into court and establish a case. Senator CONROY—Fear, uncertainty and doubt! Mr Cassidy—The fact that there is a memo in and of itself does not give us a case. We have actually got to establish what conduct was associated with that memo, what the consequence of that conduct was.

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Senator CONROY—Well, it was a direction from a Caltex— Mr Cassidy—Hypothetically, you could have that memo, and supposing it became public before anything was done as a result of the memo, the memo, as I say, does not give us any basis for action. Senator CONROY—Does Caltex’s official repudiation of it make a difference to you? Mr Cassidy—We were pleased to see that on behalf of Caltex but, basically, the factual situation still remains and we still have to decide whether— Senator CONROY—I am presuming it doesn’t because I presume the law cannot work on the basis that an organisation just goes, ‘No, it wasn’t us; it was that bloke,’ and that’s cool. Mr Cassidy—Look, we could have a lot shorter hearing, I suppose, if I gave you yes/no answers. I was just about in the process of giving you a long-winded ‘no’ answer. No, it does not; we still have to investigate and see what the conduct was that might have been associated with that memo. Senator CONROY—Did you, Mr Samuel, give the chair or the CEO of Caltex a ring and say, ‘Look, there is a bloke here who does not understand the compliance culture’? Mr Samuel—I do not think it is appropriate to answer that, Senator. Senator CONROY—Did you phone or speak with management or the chair of Caltex to talk about the issue? Mr Samuel—Yes. We have had meetings with the CEO of Caltex, their legal counsel and compliance strategy operations, and those are ongoing discussions and ongoing meetings that are taking place. Senator CONROY—But did you give them a ring when it was first drawn to your attention? What was the process you engaged in? Did you give them a ring? Did you get your office to set up a meeting and take Mr Cassidy down with you? Mr Samuel—No. Officers set up a meeting and three of us met with the CEO of Caltex and various officers that were involved in the relationship between Caltex and its franchisees. Senator CONROY—Did you speak to anyone from Caltex prior to that meeting? Mr Samuel—I have many occasions when I will be speaking to business people— Senator CONROY—No. I am talking about Caltex specifically. Mr Samuel—So in that context, yes, I would have spoken to Dick Warburton, the Chairman of Caltex, and on occasion I had discussion with Dave Reeves when I first met him. He asked to meet me when he took on the role. Senator CONROY—My question is: between when you were first aware of the memo and the meeting taking place, did you have any conversations with anyone from Caltex, from Mr Warburton down? Mr Samuel—I am trying to remember but I do not think I had any discussions prior to the meeting being arranged. I think the moment we became aware of the memo a meeting was arranged involving two officers of the ACCC.

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Senator CONROY—You did not give him a ring and say, ‘Hey, Dick, what’s going on’? Mr Samuel—No. That was dealt with by the process of organising a meeting. I could be wrong; I just cannot recall, but I do not think so. I am just trying to remember whether— Senator CONROY—We are entitled to access to your phone bill and the phone numbers you have dialled. Mr Samuel—That is right. I am just trying to remember whether in fact I might have had a call from the CEO of Caltex; whether in fact he might have called me to say, ‘Look, you have become aware of this memo. You have seen what has been reported in the newspaper. I want to tell you that these are the steps we have taken,’ and then following that a meeting had been arranged. But that is the most that I can recall, if that has occurred. Senator CONROY—Thank you. I would like to turn to the creeping acquisitions part of the report which dealt with— CHAIR—Senator Conroy, how much longer are you going to be? I am conscious that there are pressures on Mr Samuel’s time. I was told that he had to be away 10 minutes ago. Senator CONROY—I appreciate his generosity so far in not pulling stumps on us. Mr Samuel—I have just cancelled another appointment in this building. Senator CONROY—I was probably planning on being no more than another 10 minutes. CHAIR—Senator Allison also has some questions, so can you kind of go through those 10 minutes as fast as possible, if that is not illogical? Senator CONROY—I will be absolutely as fast as possible. I refer to the creeping acquisitions part of the report which dealt with a proposal by Coles to acquire 20 independent grocery outlets. Mr Cassidy, I assume that this was a major piece of work on creeping acquisitions that we discussed at estimates in June last year? Last June you stated: ... we are at the moment doing some theoretical work supported by some market inquiries to see whether we can put together a case to then present to counsel in relation to creeping acquisitions. That is with a view to getting senior counsel and possibly the court to rule on or indicate what the application of the merger law is in creeping acquisitions. We think it would be useful in the current debate or discussion to get some clarification of, in a practical sense, how useful the current merger law is in relation to creeping acquisitions. The report indicates that the commission has failed to achieve this objective in relation to this case, doesn’t it? Mr Cassidy—We did a lot of work on looking at the proposition that creeping acquisitions, particularly in the retail grocery sector, could have an anticompetitive effect through their, if you like, upstream effects on grocery wholesaling, and this is mentioned in the report. The sort of proposition is that, while individual acquisitions do not breach the relevant provisions of the Trade Practices Act, if you put the acquisitions together and look at their impact in terms of reducing the volumes that would be available to independent wholesalers, that upstream effect could constitute a substantial lessening in competition under the act. We spent quite a deal of time looking at that. We had various economic consultants looking at it. We had work done by economic consultants on behalf of some of the players in the retail grocery sector, which was also presented to us. As we indicated in the report, at the end of the day we

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 57 could not find those sorts of upstream effects, simply because over recent years in Australia the independent grocery sector has been doing quite well—by that I mean the IGAs, the ALDIs the Foodlands—so that we did not get, if you like, the economic impact that we were looking for, and on that basis we had nothing to put to senior counsel in terms of getting legal advice as to whether the particular conduct resulted in a substantial lessening in competition. In other words, the economic impact was not there; we did not get past the first step. Senator CONROY—I am very conscious of not wanting to deny Senator Allison the chance to question Mr Samuel. I still have some more questions for the commission. I appreciate that Mr Samuel will not be here after lunch, I will give Senator Allison a go and I will happily take up discussions on this issue after lunch. Senator ALLISON—My questions are about tobacco, as you might expect. Can you inform the committee about the ACCC’s work on the ‘mild’ and ‘light’ issue? Where you are up to? Mr Cassidy—I know we have had to say this before: we are still in the investigation phase on that. That is proving to be enormously complex because we are finding that the sort of evidence we need is not available in Australia, in terms of epidemiological studies and so forth. They are basically overseas studies. We need to be able to develop the linkage between those studies and what might be happening in Australia, and that includes such technical things as having to establish that the way in which cigarettes are made in Australia is the same as the way in which they are made in the countries in which the studies have been done. Senator ALLISON—So you have not been able to establish that? Mr Cassidy—No, that is something we have to establish. You may think, ‘This evidence and these sorts of studies exist overseas. Why can’t we just use them?’ but the problem is that, in order to use them in an action in Australia, we have to actually make the linkages—if I can put it that way—and that is what we are in the process of doing. Senator ALLISON—Why can’t you just get the tobacco companies to provide that information? Mr Cassidy—Without wanting to discuss exactly what we are doing in the investigation, that is the sort of thing we are in the process of doing. We also have people currently overseas as part of the investigation, so it is continuing. We are hoping to be in a position in about the next six to eight weeks of having something in front of the commission for the commission to decide on what will happen in relation to the light and mild investigation. Senator ALLISON—To what extent is the delay in implementing the government’s graphic warnings—I think they were due to be implemented in mid-2004 and now they are not going to be implemented then—dependent on your investigation? Mr Cassidy—There is really no link between the two. You could think of it as being two phases. If, as part of the graphic warnings, the advertising in relation to light and mild were changed, you would then have the issue of the conduct before the advertising was changed and then whether the new advertising is adequate or not. We are investigating the conduct that has already occurred. As part of the resolution of that, you may well look for some change in

ECONOMICS E 58 Senate—Legislation Thursday, 19 February 2004 the way in which light and mild cigarettes are advertised in the future. But there is an issue to be looked at, regardless of what happens in relation to future advertising. Senator ALLISON—Altogether, how long has the study on mild and light been going? Is it two years? Mr Cassidy—About a year and a half. Senator ALLISON—Does the ACCC have sufficient resources to put into this investigation? Mr Cassidy—We are not resource constrained in terms of this particular investigation. We of course have more general resource issues, which we are currently discussing with the government. But I could not say to you at this point that our light and mild investigation has been impeded by a lack of resources. Senator ALLISON—Could I ask about what you have just mentioned. Mr Samuel, you are having discussions with the government at present about resources. I presume that is in relation to comments made recently in the press about there not being sufficient funds to undertake litigation. You say you are talking with the government but, no doubt, you would not want to tell us what that means. When do you expect talks to be completed on that score? Maybe the minister can answer this question. Mr Cassidy—We are talking to the government in the context of the next budget, so decisions will be made and outcomes will be known in the context of the next budget. Senator ALLISON—We look forward to that. Mr Samuel—It would not be fair to indicate that our current resources are preventing litigation being undertaken, but they have the potential to do that, particularly where the litigation is lost by us. Where it is lost, particularly where big issues at the moment are being taken through to the High Court, it can be very costly to the ACCC and can blow our litigation budget right out of the water. Senator ALLISON—Tobacco smoking is blowing our health costs right out of the water, so it is a question of what is the cheapest, isn’t it? I wonder if you have had a chance to look at tobacco product placement in film and whether this is something in which the commission is interested? Mr Cassidy—It is certainly not something that we are looking at. As you know, there are various bits of regulation that relate to tobacco advertising. I think that sort of issue would probably fall to the more general prohibitions on the advertising of tobacco in the media. Senator ALLISON—So there is no element of it that might be said to be about deceptive behaviour or unconscionable behaviour? Mr Cassidy—There could be, but it is not something that we are currently looking into; nor am I aware that it is something about which we have had specific complaint. Senator ALLISON—Would it help if you did? Mr Cassidy—We try to respond to all complaints. If you think there is an issue there for us to be looking at, we would obviously be quite happy to receive whatever you want to send to us and we will have a look at it.

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Senator ALLISON—We will see what we can do. I want to go back to the mild and light question. A study was released just in the last couple of weeks about low tar and medium tar which found no difference in terms of the cancer risk. Will you fold this into the mild and light investigation question and examine the extent to which the tobacco companies understand the value or otherwise of low and medium? Mr Cassidy—That really goes to the heart of the investigation. There is no doubt that these so-called light and mild cigarettes do have less tar and less nicotine than the standard cigarette, but the real issue is whether there is any difference so far as the smoker is concerned in terms of the impact on the smoker and the smoker’s health. So that really goes to the heart of the issue that we are looking at. Senator ALLISON—Have you considered whether the unconscionable behaviour of tobacco companies ought to lead you to recommend a regulatory system for the safety and relative hazards of the components of cigarettes? I am not sure whether this is within your scope. Mr Cassidy—The unconscionability in terms of the Trade Practices Act is really specified as being between two parties, one dealing with the other. If you like, if you think of tobacco, you have three parties: the tobacco companies, the retailer and the consumer. We have trouble seeing how our particular unconscionability provisions in the Trade Practices Act would come into play, because there is no direct transaction involved between the consumer and the tobacco company because of the retailer being in the middle. That said, if, as part of our investigation, we felt that there was a regulatory deficiency involved—if I can put it that way—that would certainly be something that we would draw to the government’s attention. CHAIR—Quite apart from the fact that the unconscionability provisions of the act are not directed to the characteristics of the product but to the nature of the dealings between the two parties to the transaction. Mr Cassidy—Yes. That is fair. Senator ALLISON—But are you saying that, if there were a deliberate ingredient or substance within cigarettes that enhanced the addictiveness of them, then that would not be something the ACCC could consider if that were hidden, and hidden by virtue of the non- disclosure of that intent? Mr Cassidy—We have had it put to us that there are unconscionability elements in the whole tobacco question. As I have said, we struggle to see how our unconscionability provisions apply. The sort of issue you are raising would be one for the product liability provisions of the act and indeed whether tobacco cigarettes are fit for purpose, which is one of the requirements under those product liability provisions. That sort of issue is one that gets looked at in relation to the product liability provisions rather than unconscionability provisions. Senator ALLISON—You say it ‘gets looked at’. That is my question: is it being looked at?

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Mr Cassidy—We have looked at it and thought about it in the context of a lot of the documentation, particularly that which has come out of the US private actions on tobacco. We have not reached a conclusive position on that. So it is something that we are still looking at. Senator ALLISON—To what extent are you constrained by the lack of the requirement for disclosure? Mr Cassidy—What sort of disclosure did you have in mind? Senator ALLISON—Disclosure about the ingredients, the contents and the purpose of various elements of cigarettes. Mr Cassidy—That is not really an issue for us, in the sense that, in the product liability provisions, disclosure does not remove the requirement that a particular product has to be fit for purpose. I realise it is an issue in other areas of public health policy in relation to tobacco, but it is not something that comes into play so far as we are concerned. Senator ALLISON—I am looking for some of the barriers that might be there for harm minimisation, for instance. Do you see any barriers in the current laws that you operate under in your jurisdiction? Is there a regulatory approach which might have in mind harm minimisation through product change and product regulation? Mr Cassidy—At this stage we have not concluded that our law is deficient. There is a range of regulation relating to tobacco, some of which is more in the health area than, say, the legislation relating to tobacco advertising and the legislation that is currently under consideration in relation to health warnings on tobacco. As I said, we certainly have not decided that our law is deficient. There is a broader issue, which is probably the one you are raising, which is not just for us. That issue is, if you look at the different bits of regulation relating to tobacco including the Trade Practices Act, whether in total that regulatory regime is adequate or not. That is something which is beyond us. It is certainly not our remit to look at legislation— Senator ALLISON—I just thought you might have been able to give us some clues; that is all. Mr Cassidy—in another area and say, ‘This legislation is not what it should be.’ But I realise there is a broader public policy issue that you are raising. Senator ALLISON—I want to talk about how tobacco company mergers have affected the Australian scene. I think it is 12 months down the track now. Has the ACCC had a look at the outcome of that with regard to collusion and the behaviour of tobacco companies? Mr Pearson—We do not monitor following the merger. Any assessment of the merger at the time is based purely on competition issues, and following that we just leave it. Any issues to do with collusion would have to be brought to our attention by people in the market. We do not actively monitor the market following the merger assessment. Senator ALLISON—Mr Cassidy, you would have an interest in monitoring this, given the work you are doing on tobacco at the present time.

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Mr Cassidy—Indeed, although I would have to say that we have not had any complaints about collusive activity. That is not really something that we are currently looking at in relation to our tobacco investigations. Senator ALLISON—Do you need a complaint? Mr Cassidy—There is nothing that says we cannot look at something off our own bat, and indeed we do do that. But, equally, normally we operate on the basis of having some sort of indication or suggestion that there is something wrong or might be something wrong, simply in terms of the number of complaints and inquiries we get. We normally concentrate our efforts where we have some reason to believe that there might be something going on that should not be. Senator ALLISON—Finally, when do you expect to make a formal report back to the Senate on its motion? Mr Cassidy—We realise that we still have outstanding issues in reporting to the Senate. We thought that the next obvious point for us to report to the Senate would be when we have reached some sort of decision on the ‘light’ and ‘mild’ investigation. I think that will be the next major piece of information we can give to the Senate. Senator ALLISON—And that will be in six to eight weeks, you say? Mr Cassidy—We hope to be in that position in about six to eight weeks. CHAIR—Thank you, Senator Allison. Thank you, ladies and gentlemen. Thank you, Mr Samuel, in particular, for your patience and your indulgence in postponing your other meeting. You are excused. The other officers of the ACCC, though, will be required for further questions from opposition senators after 1.30 p.m. Proceedings suspended from 12.33 p.m. to 1.36 p.m. Senator STEPHENS—In September 2003 the ACCC rejected the undertakings given by AGL in relation to its acquisition of Loy Yang Power. I understand the normal procedure in such a case would have been to ask AGL to abandon the merger at this point and, if they refused, seek an injunction. Is that the normal procedure? Mr Cassidy—Yes. Senator STEPHENS—So why did it not happen in this case? Mr Cassidy—We had a lot of concerns about the AGL-Loy Yang merger and, in fact, still do, notwithstanding the decision of the Federal Court. Our legal advice at the time was that we probably did not have sufficient evidence to get an injunction to stop the merger. Therefore, as we believed we were entitled to, we reserved our position in terms of future action. Senator STEPHENS—Did the commission feel that it would have more bargaining power with AGL by threatening divestiture? Mr Cassidy—I do not know about more bargaining power. Basically, as I said, the position was that we had legal advice and therefore we reserved our position. We were confident that with more time we could develop a better case, so it was not a bargaining strategy in terms of

ECONOMICS E 62 Senate—Legislation Thursday, 19 February 2004 threatening divestiture somewhere down the track. It was simply a matter of time for us in developing our case. Senator STEPHENS—Were you able to extract any undertakings from AGL on the issue? Mr Cassidy—We are in the final stages after the court decision, and the court actually obtained some undertakings from AGL. We obtained undertakings supplementary to the court undertakings, which are really aimed at helping us to monitor compliance with the undertakings given at a court. Senator STEPHENS—Was this the first time that a company has sought a declaration from the court that an acquisition did not breach section 50? Mr Cassidy—It is the first time a company has sought a declaration from the court in relation to a merger’s matter, full stop. Senator STEPHENS—Was it the full commission that decided not to seek an injunction? Mr Cassidy—It was. Senator STEPHENS—And in his judgment Justice French stated: The ACCC has not proceeded to claim injunctive relief, but has threatened post acquisition divestiture action. It is not in the least surprising that AGL would not wish to enter into this major transaction with the sword of Damocles hanging over it and other members of the consortium. Indeed, it is difficult to see, if the transaction were to proceed in the face of such a threat, how public interest would be served with such uncertainty hanging over the operation of a major public utility. Do you accept that the commission’s decision not to seek an injunction was in the public interest? Mr Cassidy—As I say, it was a decision based on the legal advice that we had. Even with an injunction, we need to convince the court that there is a substantial issue involved and what the balance of convenience is for the court in terms of minimising disruption, as it were—in terms of granting an injunction or not granting an injunction. Even though it is an injunction, we will have certain requirements on us, and with legal advice that we probably did not have the basis for getting an injunction we really had no choice: under Commonwealth model litigants policy and the associated legal services directions, we just cannot go into the court if our legal advice is that we do not at least have some prospects of success. Senator STEPHENS—Okay. Has that now set a precedent or will the commission revert to the previous practice of seeking an injunction where it opposes a merger but the party indicates it intends to proceed? Mr Cassidy—I do not know that AGL was an unusual circumstance. I do not know that it was a change in our practice, in the sense that if our legal advice had been that we had sufficient to obtain an injunction then we would have sought an injunction against AGL. In the future in a similar situation, if our legal advice is that we have sufficient to obtain an injunction, then we will seek an injunction. If not, then that is something obviously the commissioner would need to consider at the time. We do not see it as in any way out of the ordinary, if you like, that we should reserve our position on something which is quite open to us in a legal sense. It is just that mergers are sometimes time sensitive and sometimes there

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 63 are time constraints involved that may not suit the merger parties if they are wanting a definitive outcome. On the other hand, we are quite within our rights to reserve our position. In terms of what Justice French said, we did not actually say to AGL, ‘We will see divestiture some way down the track.’ All we said was we were reserving our position, and it may well have been that we would have been able to assemble our case before the transaction had actually been completed. So the possibility of divestiture some further way down the track was only one of a couple of different scenarios that could have played out. Senator STEPHENS—When you say ‘reserve your position’, is it likely that the commission might in the future choose to appeal the decision, even though you announced in February that you were not going to? Mr Cassidy—No. The way in which that works is that, having got a decision from the Federal Court, there is then a limited appeal period. On the basis of legal advice we decided not to appeal. So we no longer have open to us the option to appeal the Federal Court decision. We are still very concerned about the implications of the AGL-Loy Yang merger and the reintegration that it represents within the national electricity market. That is something that we are in the process of writing to Commonwealth and state governments about, because we think that is a policy issue that the governments perhaps need to think about. Senator STEPHENS—The commission had expert advice that this acquisition would probably lead to a significant increase in electricity prices, didn’t it? Mr Cassidy—That is correct. Senator STEPHENS—Who provided that advice? Mr Cassidy—Professor Wallach, who is a well-known American academic. In fact he was engaged to help sort out the so-called Californian crisis in their electricity industry. Senator STEPHENS—And yet that was not enough to convince the courts. Mr Cassidy—It seems not, given that the court’s decision did not go in our favour. Senator STEPHENS—So who provided the counter advice that convinced them? Mr Cassidy—This was a case that was thick on the ground with legal counsel and expert witnesses. Perhaps one of my colleagues can tell us who was on the other side. Mr Pearson—There were a number of experts on both sides. AGL in particular had hired local and international experts. One of the issues in any case where you are trying to put a quantitative argument based on expert evidence to a court is the inability to get market based evidence. We had people in the market who had initially expressed concern to us but then were not willing to stand up as witnesses. Without market based witnesses it is extremely difficult to carry the case forward or to actually win the case. Senator STEPHENS—Thank you. We might move on to the issue of troublesome executives. We have not dealt with that one, have we? Mr Cassidy—I think we might have done that one. Senator STEPHENS—We do not have a very good system of actually marking these off. Have we dealt with enforcement issues?

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Mr Cassidy—It depends what they are. Senator STEPHENS—There are some questions about cartels. Mr Cassidy—Yes, we have done that one. Senator STEPHENS—Sorry about this. It must be a good lunch. Have we dealt with compensation orders and remedies? Mr Cassidy—No, we have not dealt with that one. Senator STEPHENS—I understand that recently you had a case against Medibank alleging misleading and deceptive conduct. Mr Cassidy—That is right. Senator STEPHENS—The potential liability in that case was estimated at $90 million, but the court held that the commission’s powers do not go as far as to allow orders to compel compensation to those who are not parties to the action. What happened in the Danoz Direct case about fitness machines? Mr Cassidy—In the Medibank Private case we believed that under section 80 of the Trade Practices Act, which is the injunctions section, we were able to get a court order for compensation where someone had engaged in misleading and deceptive conduct and had obtained money as a result of that misleading and deceptive conduct. What the High Court ultimately said in the Medibank Private matter was that we cannot use section 80 for those sort of compensation orders. Indeed, although this is less clear, the court also seemed to say that we could not use it for refunds either, the difference being that with refunds you can specifically identify the people involved. That left us in a position with Danoz Direct whereby, even though we were able to prove our case of misleading and deceptive conduct— there was an amount of about $15 million involved in the sale of the weight loss belt—we were not able to get anything in the way of compensation or refunds for consumers who had purchased these products. That is something we are still in the process of looking at in terms of whether that section is now deficient and something we need to approach the government about in a policy sense. We have not reached that position yet because we are still exploring what the options might be in the courts following the High Court decision, but it is a serious issue as far as we are concerned. We do have a possibility of representative action available to us, but then the issue of representative actions is, of course, that you have got to (a), have the people identified and (b), one way or another they have got to consent to the representative action. So it means that representative action is potentially useful where you have got a small number of affected consumers, but where you have got a large number of adversely affected consumers, then representative action becomes very cumbersome. As I say, we are still in the process of thinking through the implications of the High Court decision, but it does worry us, and it does seem to have somewhat reduced our ability to obtain compensation or refunds for consumers where they have basically been ripped off. Senator STEPHENS—When you say you are in the process of considering what your options might be, have you got as far as perhaps internally considering the issue of possible amendments to the act?

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Mr Cassidy—That is part of our thinking. If we were to approach the government and say, ‘Hey, we have had this High Court decision and we have now got a problem,’ the government would quite reasonably ask us what in our view needs to be done. That is the sort of issue we are now contemplating because there is a constitutional issue involved here in relation to compensation, so it is not clear that it is just an easy matter of amending section 80. We are currently thinking about whether as some sort of remedy this might require a change to the injunction provisions, or whether it might require a change perhaps to the class action provisions in the act. So we are, if you like, thinking about several different aspects of it at the moment, including really coming to grips with what the High Court’s decision actually means. We do have other cases on foot which will probably test that and help us to establish just how limiting the High Court decision is. Senator STEPHENS—Do you consider that this is a priority issue for the commission? Mr Cassidy—It is certainly one that is concerning us, and it is one that we feel we need to get a resolution to, either through the courts or, if not, by approaching the government, because it does leave us in an odd position. We can get something like Danes where we are able to get a court decision in our favour but we then cannot do anything about obtaining refunds or compensation. Senator STEPHENS—I am just trying to find Senator Lundy because I know that she has some issues that she wants to address with you and some questions that she wants to ask. Senator Coonan—Could I suggest that it might perhaps be convenient to the committee if we adjourn for half an hour and get everybody who wants to ask questions lined up. ACTING CHAIR—Senators knew what time we were resuming after lunch. If they are not here to ask questions I think we move on to the next program, quite frankly. Senator Coonan—We are in your hands. I am perfectly happy, but we would all like— ACTING CHAIR—You might accept five minutes late, but not 25 minutes. Senator Coonan—We would all like to get home and move on. ACTING CHAIR—If Senator Lundy is not here by now, she is not coming I would have thought. She has had 25 minutes. Senator STEPHENS—Can I suggest that we take a brief recess until 2 o’clock and try and chase her up. I am not too sure whether Senator Allison had finished her questions either. Senator Coonan—I think she has. ACTING CHAIR—We will resume at 2 o’clock. Proceedings suspended from 1.55 p.m. to 2.02 p.m. ACTING CHAIRMAN (Senator Chapman)—I call the committee to order. We will resume with questions to the ACCC. Senator STEPHENS—I have a question on Qantas. Back in November, the commission dropped its section 46 case against Qantas. Can you tell us what changed your mind after two years of investigation?

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Mr Cassidy—What changed our mind was that both sides, both ourselves and Qantas, had to file our evidence with the court. When our legal advisers and counsel saw the Qantas evidence it added a rather different dimension to the case and having assessed that evidence the advice we received was that we had relatively poor prospects of success. On that basis we decided to discontinue the case. Senator STEPHENS—That was two years work. That was quite a significant effort. Mr Cassidy—Yes, I know. The way the legal process works we think we have a case but you do not know the real strengths or otherwise of that case until, through the discovery process, you see what the other side’s case is. You are quite right, it was two years work and from memory somewhere in the order of $1million to $1.5 million. Equally, having received the advice we did, we felt we had no choice but to discontinue because I do not think we could have justified spending the money because, as you know from another context, section 46 cases are very expensive and prospectively if we had gone to trial and lost and then had to pay not only our own costs but also Qantas’s, we probably would have been looking at an all up bill somewhere in the $8 million to $10 million mark. Senator STEPHENS—I hope this is not seen as being a hypothetical question, but would you have continued if the law was amended in the way in which the commission recently suggested to the Senate inquiry? Mr Cassidy—In this particular case, probably not. It went to the issue of purpose and what Qantas’s purpose was in putting the extra capacity on the Brisbane-Adelaide route and reducing their prices. The essence of the problem was that the Qantas evidence seemed to establish a reasonably sound commercial purpose for that behaviour, which we had not seen until we saw their evidence. So the sorts of changes that are being discussed in relation to section 46 probably would not have had any particular bearing on the Qantas case. Senator STEPHENS—In hindsight, would you have instigated that case in the first place? Mr Cassidy—Hindsight is always a wonderful thing, Senator. At the time that we instigated the case, which was after the Ansett collapse, Virgin had entered the market but was still in the process of trying to acquire market share and there was fairly vigorous competition going on. We were concerned by what we saw. I must say it was not only the Brisbane- Adelaide route; we looked at the behaviour on a number of routes. I think on the basis of what we had before us, if we had the same material before us again, we would probably make the same decision in terms of instituting the case. It is just one of those situations where we got to court and got to see the other side’s evidence, and we found that our case was not as strong as we had thought. Senator STEPHENS—You said in your release that one of the reasons you dropped the case was because of a further review of the domestic airline market. Was that taking into account the entrance of Virgin Blue? Mr Cassidy—Yes. Senator STEPHENS—Okay. Is that a relevant consideration under section 46? Mr Cassidy—The fact that Virgin stayed on the route and that Virgin remained as a competitor probably would have made it harder for us to argue the case in court. Indeed, if we

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 67 had argued the case, it is quite possible that, amongst other things, Qantas may well have picked up the High Court’s decision in Boral. While I do not think it would have been their primary line of argument, because, as I say, obviously their primary line of argument was the purpose involved, nonetheless in terms of the Boral judgment, the fact that we still had the competitive conditions that we had in the airline market probably would have added to our difficulty in arguing the case in court. Senator STEPHENS—In fact, Mr Samuel actually was quoted as saying that Virgin had survived and thrived. Do you think section 46 requires the ACCC to show a corporate dead body in order to succeed? Mr Cassidy—I suppose that is one of our worries from the Boral High Court decision. What that decision seems to say is that if competition continues and if the competitor survives, then there is a real question mark about whether you have a section 46 case at all or whether you just have vigorous competition. While the High Court certainly did not say this in Boral, what they did say had a bit of a flavour about it that said to us, ‘Perhaps we almost need a dead body’—as you put it—‘before we can meet the sort of test that was applied in Boral.’ Senator STEPHENS—That being the case, it is almost adding a new dimension to section 46, is it not? Mr Cassidy—It could well do. The upshot is that the section is interpreted as saying that you not only need to have market power and use that market power for a prescribed purpose relating to a competitor, but you also need to be effective in having knocked out that competitor. That would tend to give it an extra dimension. Senator STEPHENS—Professor Fells recently remarked that unless section 46 is rewritten and strengthened, the Australian economy, small business, farmers and consumers will be harmed. He also stated that failing to act is not an option. Given the commission’s submission to the Senate references committee I presume that you would you agree with that sentiment. Mr Cassidy—Regarding the comment about failing to act, that is obviously a matter for government and parliament. As the chairman said earlier, we believe, given the deficiencies in section 46 at the moment, it is having an adverse impact as far as small businesses and consumers are concerned. Senator STEPHENS—Have you raised those issues with the government formally? Mr Cassidy—No. At this stage we have made our views known to this committee. Of course, that is public so we take the view that the government would be well aware of our views on section 46. Senator STEPHENS—Thank you very much. ACTING CHAIRMAN—Are there any further questions? Senator LUNDY—My questions relate primarily to telecommunications competition. I also have some queries and a couple of examples of complaints I have received from consumers about telecommunications, and I will turn to them first. I have received quite a specific complaint, so I would like to know if the ACCC has any power to take any action or

ECONOMICS E 68 Senate—Legislation Thursday, 19 February 2004 pursue this complaint. It is from a constituent who has been receiving broadband advertising for some months now from Telstra for their ADSL service, but that service is not available in their exchange. They know this because they have made that inquiry, and yet they are still specifically receiving that advertising, not only electronically—that is, through television and radio and so forth—but in their home. That is the first issue. The next thing is that residents in that area have not been advised how many of them need to express a specific interest in attaining an ADSL service before Telstra will tell them whether they will make an investment decision. We know from evidence presented by Telstra that they effectively retain the decision of whether it is a commercial proposition for them to install ADSL equipment in a given exchange. Therefore, the complaint from the residents is that they have not been given any indication from Telstra as to what would constitute sufficient numbers to make that an economic proposition for Telstra. In other words, they are feeling quite powerless in trying to either secure a commitment or at least get a benchmark from Telstra as to how they would get that service. The next point is that they do have ISDN services available, so when complaints are made about the slow dial-up interconnection speed, Telstra upsells them ISDN services, which they do not think is fixing the problem of slow line speeds. This person is particularly upset because the ISDN modems that they are up-sold by Telstra apparently, and this is an allegation, have a problem working with 32-bit operating systems, for example, Microsoft NT and XP. Apparently, Telstra is having the manufacturer of the ISDN modems look at this problem. The allegation is that Telstra has known about this problem specifically since November last year and the fault requires the system to be rebooted. I am not aware of any more problems other than a quick fix is to put it on a serial cable rather than a USB cable which leads to a slightly slower speed. The issue there is if Telstra, and this is my interpretation of this problem, are aware of a problem with their ISDN modems with 32-bit operating systems, why are they still able to sell them? What this constituent is complaining about is why, when they are getting slow speeds anyway, they are up-sold to ISDN saying it is going to fix their problems. Can you give me an idea of what powers you have under the Trade Practices Act to address this problem, if these allegations were in fact true, whether you have heard of this problem, and whether you are in a position to pursue this complaint? Senator STEPHENS—Just before you start, can I just confirm that that is the story of my life? Those are the circumstances that I am actually experiencing. Senator LUNDY—Really? Well, there you go. Mr Dimasi—So, Senator, you were the complainant? Senator STEPHENS—I was not the complainant. Senator LUNDY—I was just going to say, this email is not from Senator Stephens, it is from somebody else. Senator STEPHENS—It is just it all sounded so familiar. Senator LUNDY—Well, there you go. Mr Dimasi—We would be happy to get the details of that complaint and look at it carefully to see what indeed we could do. In particular, the last one I would be interested in

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 69 following up on the details of that. Having said that, I think that in terms of issues such as the advertising question, we would have to see whether there is indeed any possibility of misleading conduct perhaps but in general it seems that a number of the issues you have raised might relate to the obligations that Telstra has to provide service which do not go to ACCC responsibilities in terms of competition. Senator LUNDY—It is more like unconscionable conduct. Mr Dimasi—That is why I was interested particularly in the last issue, to see whether there is any possibility of that. Senator LUNDY—I think that is where the nuts and bolts are of this particular complaint. If they are selling something they know does not work still, and particularly the fact that they are up-selling, upsets people even more. If they know they are selling something that is not working correctly and then putting in a quick fix that covers up the problem in some way, then I think that is an issue of— Mr Dimasi—We would be happy to take the details of the complaint and follow it up. Senator LUNDY—Thank you for that. I have just emailed back the constituent to tell them just that. Mr Dimasi—Good. Senator LUNDY—I am sure I will be able to forward their details to you very soon. I would now like to go back to some general issues in relation to competition policy and start off by asking the ACCC what their general experience has been as a result of the latest round of legislative changes and amendments to improve telecommunications competition. That legislation went through parliament, I think just over a year ago now, so it has had some time to bed down. If you could perhaps start off by making observations about the effectiveness of that legislative amendment and whether or not it is achieving its objectives in the marketplace. Mr Dimasi—As a general comment, we are regularly required to put out reports on the state of competition and we are developing our next report at the moment so we will be able to make some fuller comments once that is completed. It is not quite ready yet. In terms of— Senator LUNDY—When will that be ready? Mr Dimasi—In terms of the timetable that we have for that, I will have to get back to you on a specific date but I think it is a couple of months away. It is certainly well underway and, as I said, we will be able to give you a fairly complete analysis of our views of the state of competition in the market at that point. In general, I guess one of the more significant changes with the last set of amendments was the record keeping rules, and we are in the process of putting those into place. I would have to say that they are fairly resource intensive instruments to work with, so I could not offer an assessment of the effect that that has had up until now. I think that is one of those things that you put into place and see the effect that it has over a period of time. But I guess it is probably—despite the fact that it is about a year—a little bit early to make direct causal links between the changes and the state of competition. I think what we are looking at is what is happening to competition in the market over a period of time, and I think in past reports we

ECONOMICS E 70 Senate—Legislation Thursday, 19 February 2004 saw a slowdown in the price decreases across the board that we had seen earlier and I think that that is a trend that we are seeing continuing. We have seen that there are still a significant number of competitors and players, but of course the numbers have tended to be smaller than they were. Senator LUNDY—They have declined. Mr Dimasi—They have declined, yes. So overall, we have seen a little bit of slowing in some of those competitive pressures. That is a fairly general remark, but that would be our observation at this stage. Senator LUNDY—In the last 12 months, have your observations in the slowing of competitive pressures become more apparent, notwithstanding that last round of legislative change? Mr Dimasi—That is what we are looking at with our report at the moment. We have not quite completed that, and I will be able to give you an answer to that question fairly soon, but I think we would just need to go through the process of completing our assessment of the data and what is around before I can answer that question. Senator LUNDY—But that would be consistent with the observation in the emerging markets report anyway. Mr Dimasi—They were the observations that were made in the emerging markets reports that I just mentioned. Senator LUNDY—So there is nothing in what you are currently working on that indicates any change in that observation or, in fact, any improvement? Mr Dimasi—Not to my knowledge. Senator LUNDY—I am just going to the specific elements of that legislative change. One of the areas you mentioned was the record keeping rules. In terms of the implementation, can you give me a brief overview as to what that involves and at what stage you are at in the overall implementation of those new rules? Mr Dimasi—We have put out some record keeping rules. We have been working intensively with the industry, and we have certainly been collecting information and we are in the process of processing it at the moment. It is has been a fairly intensive amount of work for both us, and I think for the industry as well, to collect information as set out by those rules. If you have a more specific request, I would happy to try to deal with that. Senator LUNDY—In terms of the collection of information to satisfy those new record keeping rules, what sort of information specifically are you collecting, and are you experiencing any unforeseen delays in collecting it? Mr Dimasi—In terms of the specific information, I am happy to get back to you; I just do not know all the details of the rule here with me. But, as a general process, as a general comment I would not say we that we are having difficulties with it. I think when you go into these processes and issues about what is available, what is possible, what is feasible which we are working through with industry, we are not suggesting that there has been lack of

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 71 cooperation by members of industry; it is a question of working our way through to have satisfactory sets of information and records to use for our mutual purposes. Senator LUNDY—I will try again. It has been over 12 months now. I presume this process started after it became law. Remind me, in that legislation is there a date of commencement for the new record-keeping rules that determines your timetable for collecting this information? Mr Dimasi—There are a couple of things here. I will have to get back to you on whether we have dates. In December we released a discussion paper. We are currently testing some of the key performance indicators and some of the issues in that paper. I will have to get back to you about when we have to do it. I do not recall whether we have a statutory timeline on that. Senator LUNDY—I cannot remember either. Going back to my original question, in terms of all of the things that you have to do to put those new record-keeping rules in place, are you 50 per cent of the way through or 80 per cent of the way through? How far are you from completing that? Mr Dimasi—I am not sure that I can put a number on it that I would feel confident of. Senator LUNDY—I am asking for a ballpark percentage. Mr Dimasi—I think we have done the bulk of the work in getting the key performance indicators, the information and the rules in place. My estimate is that we have done the bulk of the work and that we— Senator LUNDY—So that means more than 50 per cent? Mr Dimasi—Yes. Senator LUNDY—Does it mean 80 per cent? Mr Dimasi—I hesitate to answer that question. A substantial amount of the work— Senator LUNDY—This law is in place. I think it is an entirely reasonable question to find out how close we are to being able to enforce it. How close are we to being able to enforce a law that was put in place over a year ago? Mr Dimasi—I have no information that we are having any great difficulties in putting it into place, so I think it is well under way. I am happy to give you further details on that. Senator LUNDY—Could you take on notice providing me with as much detail as possible—not only as to what information you are seeking but about whether you have had any unforeseen delays or whether any deadlines you have set, however informal, have not been met by anybody—to start to inform the parliament as to whether or not the new record- keeping laws are going to be in a position to be complied with sooner rather than later? Mr Dimasi—We will do that. Senator LUNDY—The next area I would like to ask about is the model terms and conditions being established by the ACCC. In the broadband services competition inquiry we recently took evidence from some of your colleagues—Primus and Neighbourhood Cable, amongst others. The issue that came up there related to the ACCC’s establishment of model terms and conditions in relation to ADSL or unconditional local loops.

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Mr Dimasi—We are required to have model terms and conditions for three core services: PSDN originating and terminating, unbundled local loop and local call resale. We had a statutory timetable to put that into place, which we did. So we have established model prices for each of those services. Senator LUNDY—What were the dates on which you established each of those? Mr Dimasi—I am not sure I have the dates here with me. It was late last year. I could give you the precise dates if you need them. Senator LUNDY—Yes, if you could. We received evidence from Primus in relation to this matter. Mr Slattery said at the inquiry: My clear understanding of the recent legislative amendments, which include such things as a requirement on the ACCC to issue indicative pricing, is that a clear objective behind them was to promote commercial negotiations between the players. That was the objective behind your ability to issue indicative pricing, wasn’t it? Mr Dimasi—That is a good question. We are required to put model or indicative prices out into the market. Based on those indicative prices, the expectation of policy makers is that that creates a range or an area around which the players in the market can reach agreement and negotiate. So I would expect that that would be the case. Having said that, other processes are available—for example, the undertaking process. Telstra has put in an undertaking on those issues, which we are currently in the process of considering. Senator LUNDY—Does Telstra submitting those undertakings override your indicative pricing, your model terms? Mr Dimasi—I am not sure that the word ‘override’ is the one that I would use to describe it. What happens is that once we complete the process and we have an undertaking which specifies the terms and conditions of access to those services, then Telstra are bound to deliver on the terms and conditions that they have offered in the undertaking. Of course, that does not mean that they cannot have negotiations with other parties to vary those terms and conditions in a mutually agreed way, or have different combinations of the terms and conditions that might suit both parties. It certainly allows that, but the terms and conditions of the undertakings are binding once they are offered and once they are accepted by the ACCC. Senator LUNDY—Binding on whom? Mr Dimasi—They are binding on Telstra to deliver—or on whoever it is that offers those terms and conditions. In this case it is Telstra who has offered the undertaking; therefore, they are bound to deliver on those terms and conditions. Senator LUNDY—So from Telstra’s perspective, they would not be able to offer higher prices, for example? Mr Dimasi—They would not be able to charge higher prices, no. Senator LUNDY—But you are suggesting that they could in fact negotiate lower prices. Mr Dimasi—Yes. There is nothing to stop them doing that. Of course, they could also negotiate higher prices if the other party agreed and got quality or some other kind of service.

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We would not necessarily see that as a problem. But they would have to deliver on the terms and conditions that are offered in the undertaking. Senator LUNDY—If companies negotiating with Telstra are not satisfied with their negotiations, what power do they have to ask the ACCC to intervene? Mr Dimasi—If there were any suggestion, once we have gone through the process and the undertakings are in place, that Telstra were not delivering on the undertakings, they would be able to come to us to enforce the undertakings. Senator LUNDY—So the scenario would be that, if Telstra were only prepared to negotiate more than what was in the undertakings, that company could come and argue with you that Telstra were not prepared to agree to what they had in the undertakings? Mr Dimasi—If Telstra were not prepared to agree with what was in the undertaking, the company would certainly be able to come to us and we would be able to ensure that the undertaking was enforced. Senator LUNDY—What if Telstra refused to offer anything less than in the undertakings? Is the ACCC able to arbitrate in any way on that negotiation? Mr Dimasi—No. That was one of the changes that came through with the last set of legislative changes. The undertakings are binding, and once that decision is made it is what is in the undertaking that— Senator LUNDY—So the only power you have is to enforce the undertaking, as opposed to arbitrating in a dispute? Mr Dimasi—If there is a dispute, we can arbitrate in that dispute, but in a different way. Senator LUNDY—But not if there is an undertaking that has been accepted by you. Mr Dimasi—Yes. The arbitration of that dispute would not lead to a different outcome to what is in the undertaking. Senator LUNDY—Right. The Primus evidence goes on to say that, given that scenario you have just described, if companies like Primus, for example, are not able to negotiate a price that is less than in the undertakings then they have no recourse. They have to accept the price that is contained in the undertakings and you cannot intervene. Mr Dimasi—That is correct. Senator LUNDY—They have described that as setting rack rates. Is that an accurate observation, given the scenario you have described? Mr Dimasi—It is setting a firm price. Senator LUNDY—It is price setting. Mr Dimasi—Yes. It depends on the nature of the undertaking, of course. It very much depends on how the undertaking is structured. If you have a look at those undertakings, for example in PST and originating and terminating, what we have is a price which declines over a number of years, so it is not a single fixed price. Senator LUNDY—I appreciate that, but for the purposes of here and now.

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Mr Dimasi—It is a firm figure, yes. Senator LUNDY—In the sense that the original aim was to facilitate commercial negotiations, do you think that the changes to the legislation, particularly the lodging of undertakings that match effectively the ACCC model terms and conditions, have not had the desired effect of encouraging commercial negotiations but, rather, have allowed Telstra to set a rack rate, or a fixed price, for the purposes of determining to the market what the market has to pay? Mr Dimasi—I am not sure that I would characterise it quite that way. Senator LUNDY—How do you characterise it? Mr Dimasi—I would make two observations: first, prior to the changes that we had, one of the complaints was that there were too many arbitrations that were taking too long, and indeed there was some dissatisfaction from the market with the process of arbitration; secondly, when you say Telstra had set the price for the undertaking, indeed Telstra had an undertaking into the ACCC prior to our setting the indicative prices. The indicative prices that we came up with were significantly below the prices— Senator LUNDY—Didn’t Telstra come back with a second undertaking? Mr Dimasi—After we put out our indicative prices. Senator LUNDY—That is right. Mr Dimasi—We are now in the process of assessing that undertaking and we are in the process of consultation. Senator LUNDY—So you have not accepted that undertaking yet? Mr Dimasi—Correct. Senator LUNDY—So the scenario I am describing is not actually in place yet? Mr Dimasi—It is not in place at the moment. That was going to be a further point: it is open for the market participants to put their case on the prices through the process of finalising this undertaking. Senator LUNDY—That is a nice segue into the next issue, which is the recent media reports about the ACCC’s investigation into Telstra’s decision to drop their ADSL and cable prices as low as $29.95 per month. I am referring to an article in the Australian this week, 17 February, headed ‘Watchdog sniffs Telstra’, another in the Sydney Morning Herald headed ‘Focus on Telstra’s broadband price cut’ and yet another in the Financial Review. All of the papers covered the story in some way. In the Financial Review and the Australian stories, there are ISPs and Primus quoted as saying that Telstra dropping their price in that way would mean that they are selling themselves, if you like—accessing the Telstra wholesale service— at a far, far cheaper rate than their lodged undertakings with the ACCC. Is that true? Mr Dimasi—We are investigating that right now. Senator LUNDY—Is that the issue that you are investigating? Mr Dimasi—We are investigating whether in fact there is a price squeeze between what Telstra is offering in its retail offering on ADSL and what it is selling to the resellers at the

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 75 wholesale level. We have had quite a number of complaints on this issue, as mentioned in some of those articles. We are following that up right now. Senator LUNDY—What relationship does that investigation have to your consideration of Telstra’s undertakings? Mr Dimasi—It does not. Senator LUNDY—It has no relationship. Mr Dimasi—This is about the wholesale and retail—the differential at which they are selling now. If that has any implications for the wholesale price of ADSL and if that in turn affects the unbundled local loop prices, that is something we will follow through once we have gone through the investigation. The inquiries that we are making are specifically related to the price of wholesale vis a vis retail that Telstra is offering. Senator LUNDY—What is your time frame from this current investigation? Mr Dimasi—That is very difficult for me to say. I have got people meeting with Telstra today on the issue. It has happened, of course, over the weekend and it is only happening this week, so we are still talking to the marketplace, following up on complaints and assessing the information. I am just not in a position to be able to say how long that is going to take. Senator LUNDY—It is a pretty hot issue on some of the ISP discussion lists, as I am sure you can appreciate, some of whom find themselves in a position of in no way, shape or form being able to compete with Telstra because Telstra have determined what their wholesale rates are, which determine their price. Mr Dimasi—We understand the issue full well and, indeed, the general manager of the telecommunications branch is personally meeting with Telstra representatives to follow up on that issue today. So we are certainly looking at it seriously. Senator LUNDY—I want to go back to the issue of the ACCC’s consideration of Telstra’s undertakings in relation to this area and again refer to the evidence we heard in Ballarat, the broadband competition services inquiry. My interpretation of that evidence from the ACCC, and I think it was Mr Cosgrave and Mr Willett on the day, was that there was potentially a place for Telstra to consider what wholesale ADSL prices were in the market in your contemplation for accepting or rejecting those undertakings. Is that the case? Mr Dimasi—Yes, that is correct. Senator LUNDY—And is that happening? Mr Dimasi—For Telstra to consider, or for us to have a look at the relationship? Senator LUNDY—In relation to Telstra’s undertakings to look specifically at prices currently in the market. Mr Dimasi—Correct. In assessing those ULL prices we certainly will be looking at the wholesale price of ADSL. Senator LUNDY—I would now like to go to the issue of bundling, following the ACCC’s decision to allow bundling. I know that Senator Stephens did ask a few questions about this earlier, so bear with me. My recollection at the time was that as part of that decision there was

ECONOMICS E 76 Senate—Legislation Thursday, 19 February 2004 at least an expectation, or anticipation, that Foxtel would be able to negotiate commercial terms with alternative infrastructure providers, that is Neighbourhood Cable and TransACT, to carry the Foxtel service. Have you followed through and monitored what has been the outcome of those commercial discussions between Foxtel and those two alternative infrastructure providers? Mr Dimasi—My telecommunications people monitor what is happening in the market generally, but I do not have any specific information about any updates on that matter. Senator LUNDY—Well, I do, from Neighbourhood Cable. They have not been able to negotiate commercial terms and that again was evidence we received in Ballarat directly from Neighbourhood Cable. Does that concern the ACCC, given the nature of the discussions at the time of the bundling content sharing deal having been concluded and an agreement struck? Mr Dimasi—We would certainly be hoping that there is negotiation and that these issues are resolved. If not, we would be interested to know why not, so we will be looking at that shortly. Senator LUNDY—So the process would be that Neighbourhood Cable would have to lodge a complaint, or can you be more proactive about it? Mr Dimasi—We would react to any concerns that are put to us, yes. Senator LUNDY—So you would act on a complaint? Mr Dimasi—Yes, we would certainly look at a complaint. Senator LUNDY—What power, if any, do you have to involve yourself in resolving that outcome? I am not sure whether you have any power at all. Mr Dimasi—It depends what the nature of the complaint is, Senator. I just cannot say. Senator LUNDY—Bear with me. I will put a hypothetical to you. Obviously I do not know any detail of the commercial negotiations between Neighbourhood Cable and Foxtel, or indeed TransACT and Foxtel, but if the scenario was that it simply came down to the price Foxtel was offering to allow that service to carry their service and those other companies were not able to make any margin on carrying that service—purely commercial considerations—do you have any power at all to intervene or express a view, again in the context that the bundling agreement allowed such a massive opportunity and advantage for Telstra to link their pay TV product or Foxtel product with their telephony and data products? Mr Dimasi—The issue would be whether the undertakings that were given as part of that process were being satisfied. We would have to have a look. If there was any suggestion that they were not, then we could make an assessment as to whether we could do anything about it. That is what we would need to look at. Senator LUNDY—Can you recall if there were any undertakings that could possibly be evoked without having received a complaint, which I presume you have not received? Mr Dimasi—I would have to check to see whether we have received a complaint. I am not aware of any. Yes, there were undertakings that were given to us. So we would have to have a look to see if there was any suggestion that they were not being satisfied.

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Senator LUNDY—Can you take on notice—and I am sure it is in the body of the agreement—to provide the committee with the specific undertakings from the bundling agreement and any tests you have devised or case studies to date where they have been challenged in any way and if they have been challenged? Mr Dimasi—We will take that on notice. Senator LUNDY—That is all I have, thank you. Senator STEPHENS—That concludes our questions for the ACCC. Thank you. [2.49 p.m.] Productivity Commission CHAIR—I welcome to the table Mr Kerr on behalf of the Productivity Commission. Mr Kerr, do you have an opening statement? Mr Kerr—I will make a couple of brief remarks to remind the committee of the projects that we have with us at the moment. By and large our material is in the public arena, so there are no great mysteries as to what we are doing. We have seven terms of reference before us at the moment, touching on issues to do with the environment—for example, the Native Vegetation Inquiry; trade—a study on the rules of origin with CER; some economy-wide issues—an inquiry into workers’ compensation and OH&S; a competition policy issue to do with the gas access regime; some social policy issues—a review of the Disability Discrimination Act and the inquiry into first home ownership; and a review which we have just received into a regulatory issue to do with the Australian building code. We have some continuing remits from COAG, the Council of Australian Governance, to do with reporting on government services such as health, education, community services and justice, and we produced about a month ago our annual Blue Book reporting on performance in these areas. Late last year we produced a report, again at the request of COAG, on Indigenous disadvantage. Lastly, our Office of Regulation Review has a continuing program of work, principally supporting the preparation of regulatory impact statements for legislation and then regulations which come before you. That is a snapshot of the current projects. Senator MACKAY—Just a couple of questions for you this time around, with respect to the Productivity Commission’s draft report on home ownership. Just having a look at it, specifically in relation to shared equity schemes, I noticed on page 152 that: ... the case for government financial support is far from clear ... a modified FHOS is likely to provide a better return to the community overall for its assistance dollar. On the housing lifeline issue, on page 154 of that report it was concluded that: ... as with shared-equity arrangements, it is far from clear that government financial support for this proposal is warranted. I am just interested to know what, in the commission’s view, the problems with the shared equity scheme and the housing lifeline are, that have led to those two conclusions? Mr Kerr—I will just make a process point first, before coming to the substance of your inquiry. What you are quoting from is a position paper, which we put out just before

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Christmas. We are in a listen and learn phase of the inquiry. The final report is due to be presented to government by the end of March, so we are in the process of listening to reactions to these ideas and trying to absorb them, and I believe we have probably had some comments on these issues, so our views are in a reformulating stage, if I can put it that way. Senator MACKAY—Sure, I accept that. Mr Kerr—We were actually asked under our terms of reference to have a look at some of these issues, which have come out of other pieces of research and inquiry—the shared equity scheme, for example, and the lifeline idea, which was something produced by a couple of academics from Melbourne University. There is a brief discussion of each of them. I might just draw on the report, looking at the key issues. The lifeline arrangement was the concept of trying to provide support to people who were unable temporarily to meet their mortgage obligations, because of employment circumstances or for some other reason. The notion was that a lifeline proposal might be able to increase home ownership by funding mortgage repayments in the event of short-term financial stress. By providing a form of income insurance, it could make the providers of finance a bit more willing to shade their risks and therefore more willing to extend finance. We thought the number of households that would benefit would depend crucially on the scheme design—in particular, whether it was means tested. So what we were playing with was looking at what the most effective scheme would be, if one were to try to assist potential home owners of that type. Would it be this scheme or some other? By and large, we felt the First Home Owner Grant scheme had as many advantages as some of these other ideas—if not more. In particular, there were a couple of reasons why the effect of the lifeline scheme for home ownership might be quite small. It does not overcome the deposit gap problem, for example, for people starting off. There are some mechanisms already available to help owners through periods of short-term financial stress, because lenders themselves may offer schemes to vary repayment terms. So it was a bit difficult to tell what additional benefit this might bring. It was not necessarily a poor concept, but it was a question of whether it had any particular advantages over others. Families also can use a number of strategies for guarding against these sorts of short-term periods of stress, including income insurance and some savings. Those are the sorts of reasons. Some of these are matters of judgment rather than being knockout issues. It is a question of weighing up the most effective way. Regarding the other example you mentioned, the shared equity arrangements, that concept was to allow a family to purchase a property but to share the equity with someone else and therefore share in the presumed appreciation of the property value. For example, in WA the government allows public housing tenants to purchase between 70 and 100 per cent equity in their current rental property under the GoodStart program. Some shared equity lending products are now being canvassed by some private lenders. There was a particular model produced by the Menzies Research Centre, which is the one that we had a look at. We got some arguments going different ways on this but one of them related to regulatory uncertainties. The Australian Bankers Association, for example, noted that the treatment of shared equity holdings by APRA could influence the attractiveness of shared equity products to banks, and to the extent that such regulatory uncertainties exist we thought some clarification would be necessary before this sort of thing would fly. So again, not that is

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 79 necessarily an idea that should be set aside, but it struck us that there were quite a few unknowns about how it would work through. We are revisiting these, and we will comment a bit further, based on the reactions we have had to our preliminary views. That is about all I can effectively say on that. Senator MACKAY—Other than me asking questions here, what sort of reaction have you had from stakeholders with respect to these issues and the draft report? Mr Kerr—I think my summary would be that the reaction to the draft report has been pretty good. It did not try to provide all the contextual information, because we were rather pressed for time. Of course, quite a few people have made suggestions as to where it could be improved. For example, the ACTU suggested that we need to give a bit more attention to lower income earners, and their capacity to enter the housing market and their needs, and we are having a think about that. But by and large I think the response to the draft has been pretty good. Senator MACKAY—Have you had any specific response to these two issues so far? Mr Kerr—I would have to take that on notice. I have not been sitting through all the public hearings and I have not read the transcripts. I can provide you with a guide to any comments on it. All the transcripts are on our website so there is no mystery about this. It is all laid out there, but I can help you find any reactions, if there have been any. Senator MACKAY—Just going back to shared equity schemes briefly, could you elaborate on how APRA treatment would affect viability? Mr Kerr—I am just going to rely on reading a short section from the draft, because that is my source of information: ... some have argued that there are regulatory and other impediments to their development or uptake. Caplin and Joye— these are the proponents of this idea from the Menzies Research Centre— ... noted that, while the introduction of shared equity can be accommodated within existing legal and regulatory frameworks, clarification is needed about whether the investor’s gain would be taxed on a cash or accruals basis (that is, periodically or upon realisation of the capital gain). And the ABA, the Australian Bankers’ Association ... stated that the treatment of shared equity holdings by the Australian Prudential Regulatory Authority would influence the attractiveness of shared equity products to banks. There is a reference to the ABA’s submission which, presumably, has a bit more detail about their particular concern, but you get the idea: there is joint ownership of a property, the property may be appreciating, the home owner is living in it and obviously while they are living in it they are not seeking to sell it so they are not realising the gain, but how is the capital gain to be treated from the point of view of the taxation of the commercial party who may have the shared equity taxation? They may be filing their annual tax returns et cetera. So there are some wrinkles there to be sorted, I think. Senator MACKAY—With respect to responses by shareholders, was there a view— bearing in mind that I have not read the transcript that you have cited—that affordable rental housing should be given a greater focus at all?

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Mr Kerr—I am sure that that view has been raised. Indeed, in revisiting these issues for the final report, I believe we are going to talk about how the different bits of the housing market fit together. We have been asked to look at a particular slice—that is, the issue of first home ownership. The art of good economic analysis is to look at all the knock-on effects and how things fit together. We are going to have to look at the wider housing market. For example, if the government seeks to look at—as the terms of reference invite us to—assisting first home owners, then you need to look at what other circumstances they might be in. So there may be choices. If the government is going to spend a certain amount of taxpayers’ money providing assistance, in which way can that assistance most effectively be delivered? Perhaps it can be delivered by providing some assistance to purchase but a counterpart—or counterfactual—might be providing some assistance through rental, either by the building of houses or by rental subsidies. Those are the sorts of trade-offs that need to be weighed up. We will try to reflect some of that in our final report. Senator MACKAY—Are you aware whether this was raised as one of the focuses at all? Mr Kerr—I am pretty sure it was raised. I believe ACOSS would probably have raised it in their appearance in Sydney. As I mentioned, I think the ACTU drew to our attention the need to pay some attention to these sorts of issues, so I am pretty sure it was. Senator MACKAY—That is fine. In its draft report the commission has not recommended specific changes to the tax system to affect housing outcomes. Can we conclude from that that the commission believes that existing arrangements are satisfactory, or is it a simply a case of determining the final position, once the final report comes out? Mr Kerr—You talk about tax arrangements. There are quite a few tax issues which affect home ownership. We had a pretty good go at trying to describe and analyse how they fitted together and what sort of impact they had. We made some preliminary suggestions in the position paper. We are revisiting those and we will put something on our final conclusions in the final report. Some of the tax issues are difficult to unbundle from wider tax policy. Where they are specific to housing we made some suggestions—for example, at the state level, stamp duty, which, whatever the revenue objectives, provides some impediments to the turnover of housing stock and people being able to move. Not everybody was impressed with the suggestions we made, so we are having a think about that. We will be revisiting the tax issues. They form part of the picture—part of the demand side, by and large—but we are trying to give pretty full attention to the supply side as well in the report. Senator MACKAY—What is the commission’s view on the existing balance of government support for owner occupied as opposed to rental housing? Have you been able to form any preliminary views at this point? Mr Kerr—I do not think we have formed a view on that, I do not think we were invited to. Senator MACKAY—Amongst other things, the commission concluded that: ... the current support provided through the First Home Owner Grant scheme and other direct assistance arrangements, might provide a greater return to the community, were it redirected into other measures to help meet the housing needs of low-income households or more broadly to the reduction of stamp duty on property transactions.

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That is from page 155 of the draft report. What is meant by ‘other measures to help meet the housing needs of low-income households’? Is this referring to the fact that the greatest pressure points on housing affordability are actually in the private rental market? Mr Kerr—I stand to be corrected after I have checked with the authors, but my reading would be that the point being made there is a fairly straightforward one. First of all, in the amount of assistance provided to housing objectives generally there are trade-offs with other government policy objectives—other social welfare objectives, for example. Then within the housing sector there are some choices that may be made on how assistance can best be provided. We made some suggestions in the position paper about the option of targeting the First Home Owner Grant scheme, if the government and parliament want to move that way. The tricky aspect there is that the origins of the First Home Owner Grant scheme lie in GST compensation arrangements, which were by definition not income level specific. So to move to a targeting scheme would mean a transition from one style of objective to another. We needed to be honest about that, because it would represent a change in tack, but it is something that we thought could be weighed up. Senator MACKAY—Is the commission aware of any work that has been done on increasing the supply of affordable rental housing? Did you come across that at all? Mr Kerr—I would need to check that level of detail with the submissions and comments on the transcript. To provide an answer at a general level, akin to the answer I gave earlier, the analysis so far spent some time talking about supply side issues. Supply of housing can be brought to use in a number of different ways, and there are some relationships between owner occupied housing and rental housing. In particular there are relationships between investment housing and rental housing. So, with regard to the so-called investment housing boom— which according to our analysis has been part of the story of the increase in housing prices— according to current reports there are signs of market cooling. One of the ways of detecting that is by looking at rental returns on investment housing stock. Another way of putting that is that there is a downward pressure being brought on rents as part of the cyclical developments. That itself would have some impact on people seeking to rent rather than to buy. So it might be quite a good time, for example, to be a renter. Senator MACKAY—Just specifically, is the commission aware of any work being undertaken by the Brotherhood of St Lawrence on affordable rental housing? Mr Kerr—I am almost certain we are, although I am not personally. I think I recall that the Brotherhood appeared at our hearings and would have had the opportunity to present and discuss their research. So I am almost certain that we would be aware of it, yes. Let me just make a more general comment about our process. One of the advantages of our public inquiry process is that it provides a platform automatically for people to bring their views and to present their material and indeed for others to draw on it—because once it is on our website and in the public arena others can go to school on it. Senator MACKAY—Is the commission able to proffer any view at this point as to how the first home owners scheme could be improved? Mr Kerr—I cannot go beyond what we had to say in the position paper. I have made a brief comment about some of the remarks we have made in there. We will have some final

ECONOMICS E 82 Senate—Legislation Thursday, 19 February 2004 views in the final report. So we will be addressing that. We did report a number of the different ways that had been presented to us which could be used to adjust the scheme. For example, it could be tuned or targeted. You could limit its application by cost of property or an income test on people who were eligible and so forth. We have presented those and we will be having something to say on those in the final report. Senator MACKAY—When you produce your final report, will you be sharpening up the observations you have made in the draft report? Mr Kerr—I do not know. It remains to be seen. Senator MACKAY—Specifically, means testing has been recommended or mooted. If that were to be the case, on an income basis does the commission have any view on what level means testing might be appropriate? Mr Kerr—No, we did not make any comments about how such an idea might be implemented. We raised it as an option, to be thought about if targeting was a preferred way of running the scheme. We did not go into implementation details or thresholds or anything of that sort. Senator MACKAY—Do you suspect that you may do some more work on that area? Mr Kerr—To the extent that we return to that issue, I very much doubt that we would have much to say on detailed implementation. I am not sure that we have the skills or information to make those judgments. I think we would leave that to government to think about if it decided to look further at that option. Senator MACKAY—With respect to finance for first home owners, does the commission have any data on the source of finance, the location of first home owners and the types of dwellings that have been purchased? Are you able to find that for the committee or would you like to take that on notice? Mr Kerr—I think I will take that on notice because, to the extent that I could hazard an answer, I do not think it will be at the level of detail that the question implies. The question implies that you need the specific data rather than whether we have the information. Let me try and bring that to you on notice. The draft report is fairly rich in information. Senator MACKAY—Yes. Mr Kerr—And there is a fair bit of information about borrowing trends and new financial instruments. There is information about purposes of borrowing, whether it is for investment properties versus owner occupied. Senator MACKAY—I guess we are after the next level back. Mr Kerr—Yes. Senator MACKAY—If you want to take that on notice and provide it to the committee if it is available, that would be great. Senator STEPHENS—Just on that issue, you may have already said something about this, but I understand that you were doing some consultation around the draft report in January and February. Is that all completed?

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Mr Kerr—Nearly. I think the public hearing phase, where we run hearings not too dissimilar from this, is completed. But we still have some further meetings to undertake. We are having a chat, for example, to the Western Australian and South Australian governments because we happen to be over there next week. There are some further meetings going on to generate information. Indeed, although we try to guide the submission process through the public hearing process, in fact people can make submissions to us at any time and we will try to take account of them even if they have not appeared in the public hearing. So it is not inconceivable some further information will come forward. By and large, most of the information gathering and response to the draft report is over and we have only got six weeks before the final is due so we are heads down trying to prepare it. Senator STEPHENS—It is due at the end of March, isn’t it? Mr Kerr—Yes, that is right. Senator MACKAY—To the government initially? Mr Kerr—Yes, we present it to the government. It is up to the government when it tables it. Our act requires it to be tabled within 25 sitting days of receipt. [3.17 p.m.] CHAIR—Thank you, Mr Kerr. I welcome to the table officers of Treasury for outcome 3, Well functioning markets. Mr Murphy, is there an opening statement? There isn’t usually from Treasury, I know. Mr Murphy—No, Senator. Senator MACKAY—I want to ask some questions with respect to the free trade agreement, so who would they be directed to? Mr Murphy—Mr Legg can answer them. Senator MACKAY—What elements of the free trade agreement did Treasury negotiate? Mr Legg—We were primarily involved in the following areas: foreign investments, financial services, competition policy and some general taxation provisions. Of those things, for the first three expertise lies in the markets group. Senator MACKAY—For the record, can you explain the changes to Australia’s foreign investment regime? Mr Legg—Sure. I will just mention a couple of things that are not changed as I think they are very important. One is that the national interest test will continue to apply to all sectors. The US were very keen that that not be the case. In fact, they wanted to change the national interest test, so we resisted that very strongly. The other point I would make is that they were also very keen on investment state dispute settlement and we resisted that very strongly too. The significant changes include an increase in the threshold for sectors other than sensitive sectors from $50 million to $800 million. A number of sectors will continue to be screened above $50 million. They are the sensitive sectors, which are telecoms; transport; defence related activities; uranium; media, which is screened irrespective of value; urban land, which

ECONOMICS E 84 Senate—Legislation Thursday, 19 February 2004 is screened irrespective of value; and purchases by governments, which are screened irrespective of value. One other change in terms of sectors—it is not actually a change in the substance of the policy, but it is a change in how the policy is given effect to—relates to the financial sector. Financial sector corporations, which are covered by the Financial Sector (Shareholdings) Act—in which there is a national interest test as well as the one that applies under the Foreign Acquisitions and Takeovers Act—will be screened through the FSSA, not the FATA, so it is a sort of streamlining process but it is not one of substance. The other significant change is that US investments in new businesses will not be screened. This reflects a judgment that new businesses do not generally raise national interest concerns that may be raised with a change of control and ownership of existing economic activities. It also reflects the fact that new businesses had previously been handled through policy and did not have legislative backing—there was no legislative power under the FATA to screen new business. In that sense, whilst it was always good to ask people to let us know, we did not really have an awful lot of power to act in the case of new businesses anyway. Senator MACKAY—With respect to the matters that you outlined initially, has Treasury seen the detail of the free trade agreement with respect to those matters? Mr Legg—Absolutely. I negotiated them. Senator MACKAY—In relation to government procurements specifically, where does Australia expect to gain from the free trade agreement? Mr Legg—That is a matter that you would have to address to our colleagues in Finance. DFAT, with their assistance, was responsible for the negotiations on government procurement. That is not something that Treasury was involved in. Senator MACKAY—I noticed that a bit of ping-pong was going on in the Finance estimates on this issue. Why was the threshold lifted from $50 million to $800 million for non-sensitive sectors? Mr Legg—There were number of considerations. Ultimately, of course, this was a negotiation, so there was a give and take, if you like. The US were, and remain, very strongly opposed to screening in any form, and they see our arrangements as a potential restriction on investment flows. From our point of view, we felt comfortable raising—and the government’s judgment was that it was comfortable raising—it that far because it achieved the balance between, if you like, the level at which national interest concerns are likely to be real and tangible and, below that level, the level at which they are not likely to be sufficient to warrant the compliance costs associated with the screening. Historically, there would be very few, if any, cases which, under the arrangements which we have negotiated with the US FTA, we could not continue to screen and do everything we have done in the past. Senator MACKAY—Why was $800 million settled on? Was there any particular science behind that figure? Mr Legg—As I said, it was a negotiation. I would not want to apply too much science to it, but the ultimate outcome was one that we were comfortable with.

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Senator MACKAY—US trade representatives say that this would have exempted nearly 90 per cent of US investment transactions from screening over the past three years. Is that correct? Mr Legg—It is correct in that, if you had applied $800 million to the cases that we had in the last three years, without also applying the sense of the sectors—that is, if you just applied $800 million across the board—I think the reduction in the number of cases would have been about 89 per cent. If you actually add in the sensitive sectors, so that we still have certain sectors where you continue to screen above $50 million or above any dollar value in some cases, that figure goes down to below 70 per cent. The other point I would make on this is that in terms of value of investment—that is, not the number of transactions but the value of investment—under the proposed arrangements with the US we will continue to screen over 70 per cent of investment by value. Senator MACKAY—Can you give me an idea of what transactions would not have been subject to FIRB scrutiny? Are there any notable examples? Mr Legg—I have not been able to find any that are notable. I think that was the point I was making earlier. Senator MACKAY—What did the US government want in relation to foreign investment? Did they want to abolish FIRB? Mr Legg—I do not want to go into the cut and thrust of the negotiations, although there was a fair amount of cut and thrust and that did go on for a fair while. They essentially would have preferred us not to have screening at all for the US if for no-one else. They had several ideas on the table as to how they thought we could give effect to that. But our judgment and the government’s judgment was that they were not acceptable from our point of view. Senator MACKAY—What are the implications arising from the increase in the threshold to $800 million? Mr Legg—I do not quite know how specifically you want me to answer that. Senator MACKAY—Maybe if you start off in general and we will drill it down if we need to. Mr Legg—The major points are the ones we have made. If the pattern of proposals is the same as it has been for the last three years, we expect to continue to be able to screen over 70 per cent of investment by value. We will be screening somewhere around 65 per cent to 67 per cent less by number. This is in terms of US proposals, because of course at this point we have just done a deal with the US, so we are not prejudging whether this is something that applies to all investment or just investment from the US. All of the cases that I am aware of where governments over the last few years have wanted to reject or impose conditions outside the normal routine urban land and real estate cases would still be able to be screened and rejected or passed. Senator MACKAY—So financial services will now be subject to the new threshold of $800 million? Mr Legg—No. Financial services will now be screened through the Financial Sector (Shareholding) Act. I am not the expert on that act. There are others here that are. That has a

ECONOMICS E 86 Senate—Legislation Thursday, 19 February 2004 different sort of threshold. It basically kicks in when an interest wants to buy 15 per cent or more of a financial sector corporation as defined under that act, or I think there is some provision about taking effective control irrespective of whether the 15 per cent applies. So the $800 million becomes irrelevant from financial sector corporations covered by that act, but the national interest test under that act will be used to give effect to the government’s policy on foreign investment in the financial sector. Senator MACKAY—Is it the case that the Australian and US financial sectors are already relatively open to each other? I am advised there are relatively few restrictions now. Do you agree that removing any current restrictions is likely to have a big impact on trade in financial services? Mr Legg—It is true that they are relatively open. That was reflected in the fact that there are not many restrictions in the financial sector that have been removed through this agreement. The benefits come in a different way. The benefits come in providing some legal certainty to the relationships we already have, and in terms of some work programs with some issues that will take a bit of time to be worked out that relate to regulatory and prudential arrangements relating to cross-border access for securities and the like. They are potentially very important processes. They are not necessarily addressing specific market access restrictions at the moment. Senator MACKAY—Is it anticipated that the increase in the threshold will increase US investment in our manufacturing sector at all? Mr Legg—I am not in a position to prejudge where increased investment may go sector by sector. It is very hard to quantify that ex ante. But there is a body of opinion which suggests that the foreign investment screening was seen as being a level of restriction which imposed compliance costs. The OECD has done some studies which ranked us as being amongst the most restrictive countries in the OECD. That may be more perception than reality, but this helps address that perception, and I think that will be powerful to some extent in encouraging flows of investment. The OECD has also suggested, were countries at the restrictive end of the OECD spectrum to move to the unrestrictive end, a figure of 40 per cent increase in investment flows. That, I think, is probably heroic, but it implies that there is a respectable body that is doing some research on this that thinks there will be material impacts from softening investment screening arrangements. So we take some comfort from that. Senator MACKAY—Given your previous comments about making judgments on a sectoral basis, what areas do you think US investors might be most interested in? Mr Legg—I think I would leave that to their commercial judgment. Senator MACKAY—So there were not any particular areas mooted in the negotiations at all? Mr Legg—No. I think the US have a broad based feeling that screening is anathema to them in any sector. Senator MACKAY—Has the FIRB been a problem for US investors in the past? Mr Legg—I do not think there have been many, if any, cases where US investors have been rejected. There may have been one or two. I think there was a US proposal to change the

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 87 articles of association of Optus in 1996, which was rejected at that time. That was because of specific restrictions on foreign investment in or foreign control of Optus that applied at that time. There was an earlier case—this is going back, I think, to the early nineties—relating to a medical company which was purchasing some medical service providers here, which was also rejected. That case would have been below the $50 million threshold. Senator MACKAY—Yes. On a more general note, the US is already the largest investor in Australia. In general, do you expect a significant increase? Presumably you do. Mr Legg—I believe that the changes that flow from this have economic potential, not just on their own but as part of the overall agreement which gives legal certainty to the services flows, strengthens cooperation in competition policy and gives greater certainty in taxation arrangements. If you take all that as a package then I would expect the interrelationship between these things to foster greater integration of the two economies. Senator MACKAY—Do you think other countries will seek to have the threshold raised for their investors? Mr Legg—They may. We will see. Senator MACKAY—Are there any WTO implications for Australia arising from this increased threshold? Mr Legg—No. Investment previously has not been a big part of the WTO. Part of the issues of the WTO at the moment concern whether it or not it should be—what is called the Singapore issue. In the GATS our pre-establishment screening arrangements are reserved against that. In fact, we have never given away any powers in that forum in terms of our foreign investment screening. Senator MACKAY—What about for our other free trade agreement partners? Mr Legg—It is not covered by the CER with New Zealand. The CER does not cover pre- establishment investments. I am not an expert on the Nara treaty with Japan, but I do not think that that covers pre-establishment investment either. Senator MACKAY—What about New Zealand? Mr Legg—The CER with New Zealand is the one I mentioned. Senator MACKAY—What about Singapore and Thailand? Mr Legg—With Singapore and Thailand we basically reserve to maintain our existing arrangements. I think we offered Singapore a help desk for Singapore investors to work their way through the process, and they were happy with that. In Thailand we bound the existing arrangements, so we said that we would never make them more restrictive than the existing arrangements. Senator MACKAY—So, based on what you say, there are no provisions in our FTAs with those countries where they could automatically demand that similar treatment be extended to them? Mr Legg—The Nara treaty has a most favoured nation clause. The assessment needs to be made as to whether that would apply to this agreement, because of the limitations of the Nara treaty. Because the Nara treaty is not about pre-establishment investment arrangements—and

ECONOMICS E 88 Senate—Legislation Thursday, 19 February 2004 concepts of investment were very different in 1970 or whenever it was that it was put together—and because the most favoured nation clause is itself drafted in a somewhat unusual way compared to the way they are drafted these days, it is an open question as to whether or not they would have a good case to make. They may try to make that case, though. Senator MACKAY—More generally, has Treasury done an assessment on the potential impact of the US free trade agreement on the Australian economy? Mr Legg—The modelling expertise does not lie in the markets group, so in that sense it would not lie with the people here. I am not aware that we have and I am not surprised that we have not. The sorts of things I was saying earlier go to the heart of the benefits. The long- term, significant benefits from this agreement will come from the dynamic interrelationship with the intangibles: competition policy; certainty; work programs on financial services, which will be done through a financial services committee that is being established between the two countries; and work programs on recognising professional qualifications, which is one of the big impediments to service trade at the moment. All of those things are very powerful but they are impossible to quantify, so what you are left with when quantifying the model are things that are easy to measure but perhaps not the most important part of the agreement. Senator MACKAY—So are you saying that the benefits are, to some extent, too ephemeral to model? Mr Legg—The benefits are hard to quantify ex ante. Senator MACKAY—Is it planned that any assessment will be done by Treasury? Mr Legg—I am not aware of any plans. Senator MACKAY—I am trying to take this to its logical conclusion. The government is asserting that the free trade agreement will have a big impact on the Australian economy. I assume that Treasury must take this into account when preparing for this year’s budget, specifically with respect to the future outlook for the Australian economy, rather than what has been stated here today. I do understand the underlying logic is ephemeral by its very nature. Presumably you will have to take some account of this with respect to projections. Mr Legg—Our fiscal group colleagues will be able to give a more definitive answer on that. I would think it very unlikely that we are going to capture all the benefits 12 months out. The agreement itself is unlikely to enter into force until halfway through the next financial year. Senator MACKAY—What about prospective? Mr Legg—You will have to ask them about that. Senator MACKAY—Mr Murphy, would you like to comment on that? Mr Murphy—No, I think that is the place to direct the question. Senator MACKAY—So, in respect of the preparation for this year’s budget, it is likely to have a negligible impact in that the agreement will not have been enforced? Mr Murphy—I think you should really direct the question to the people who are responsible for the preparation of the budget—the fiscal group.

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Mr Legg—My colleague has just pointed out to me that, whilst the fiscal group put the budget together, they would go to our macro group colleagues to get the macro analysis, so I guess it all comes back to our modelling and macroeconomic analysis team. Mr Murphy—So it may be better directed to those guys. Senator MACKAY—Ross Gittens from the Sydney Morning Herald stated, on 11 February: Assuming the deal goes ahead, you’ll need a microscope to see the difference it makes to our economy—as the Howard Government’s own studies show. Is Ross Gittens wrong? Mr Legg—No comment. Senator MACKAY—I do not mean that in a global sense; I mean in respect of that particular quote. Mr Murphy—Mr Gittens is a well-known commentator on the Australian economy and he has his views. Senator Coonan—Perhaps you could describe it as pessimistic rather than wrong. Mr Murphy—As Mr Legg has pointed out, it is going to be very difficult to discern immediate benefits that you could see. In the fullness of time or in the next 12 months, it may come through. You cannot quantify these things now. Senator MACKAY—No—I understand. But presumably, given that it has been asserted there will be a major boost for the Australian economy in future years, when the full trade agreement does come into force, there must be a view that it will impact substantially— positively—on the Australian economy, putting aside Mr Leggs’ comments. Mr Murphy—I would not have thought the government would have embarked on this project and secured a free trade agreement with the US if there were not going to be benefits to the Australian economy as a whole. Senator MACKAY—That is right, but what is your view on what they would be in future years? Mr Murphy—There will be benefits, as Mr Legg has said. One immediate benefit is the liberalisation of Australian foreign investment rules, which is a positive thing—if one believes in open economies and free trade, which we all do. So there is an immediate benefit. Senator MACKAY—Even the government’s economic modeller, Mr Stoeckel, has backed away from his earlier $4 billion figure. He said: ... there’s a whole series of unders and overs that you’d have to look at and recalculate to get any sensible number from that US agreement. We really should get away from that $4 billion estimate. And then there is the ACIL consulting report—this is all out in the public domain—that suggests the impact on Australia could be marginally negative. The IMF earlier this year also suggested a free trade agreement with the US could have a negative impact on Australia. Is it possible that the free trade agreement could have a negative impact on Australia’s GDP and have you got any comments on the two reports I have cited.

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Mr Murphy—I have no comments on the reports and I do not think I can answer that question. Mr Legg—We are not the macroeconomic analysists; we negotiated individual aspects of the agreement. Senator MACKAY—Have you got any comment on the impact on the trade balance with the US of this? Mr Legg—I think it is the same answer. Senator MACKAY—We already run a large deficit with the US of around $13 billion. Do you expect this to increase or decrease? Mr Legg—None of the chapters that we negotiated—foreign investment, competition policy, financial services—is a significant part of the trade balance. Senator MACKAY—Is there anybody here who can comment on this? Mr Legg—I think it probably comes under output 1, which is scheduled for later this evening. Senator MACKAY—We will have to run it all over again under output 1. Mr Legg—But I think the answers may well be similar in the sense that the real tangible benefits from this are going to emerge over time from many of the non-sexy parts of the agreement—that is, the integration of financial services sectors, the legal certainty in some areas and the potential for addressing concerns about professional service and professional qualifications to ensure that those sorts of impediments to service trade are removed, and the links between those things and investment. Mr Murphy—So from the perspective of the markets group we would see that it would be of benefit to the Australian economy, but we have a narrow perspective. Senator MACKAY—Chair, I do not know whether this is possible but, rather than me running through all this again when we get to output 1, could we have people here now respond to this. CHAIR—If that suits the way in which you want to attack these questions, I cannot see why not. Senator MACKAY—It might just save a bit of time. CHAIR—I think we might do that—if those officers concerned in outcome 1, macroeconomic policy, can come to the table. Mr Murphy—I do not think there is anyone here. We do not get notice of the questions. You have got the officers here to deal outcome 3, so it might be better to go through the other questions for outcome 3. People back at the department are watching and they will start moving up if you want to then move to outcome 1. I think under your schedule you had outcome 3 and then outcome 2. Senator MACKAY—Outcome 2 and outcome 1. Mr Murphy—Outcome 1 was told to be ready for after dinner.

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CHAIR—Senator, perhaps you might ask your other questions under this outcome. Senator MACKAY—Yes, I am happy to do that. Maybe people could take a note of what has been raised here so that it saves me going through everything again. Mr Murphy—I think they will be listening. CHAIR—So would those officers listening to the broadcast who are concerned in outcome 1, Sound macroeconomic environment, come to the hearing now please, and make yourself known when you arrive! Senator MACKAY—I have some questions on trade practices matters, criminal sanctions and cartel activity. I would like to ask about the implementation of the Dawson committee recommendation that criminal penalties be introduced for hard-core cartel behaviour. In October the Treasurer announced that a working party of officials would examine this proposal. This committee was due to report in December and I wondered whether this report has been received by government. Mr French—Originally the working party was expected to report by the end of the year. There have been some late submissions, and those were received quite close to the end of last calendar year. The working party is continuing at present and it is expected we would be reporting to government by some time in March. Senator MACKAY—Are you aware how many times the committee has met? Mr French—I cannot say offhand, but it has met on numerous occasions. Senator MACKAY—So presumably the Treasurer will receive it sometime during March. Is that as specific as you can be at this point? Mr French—That is correct. Senator MACKAY—I am advised that nine OECD countries have introduced criminal penalties for hard-core cartel behaviour. You would be aware of what those are. Given that we do not have to reinvent the wheel, as it were, what is the reason for the delay in moving more quickly on this matter? Mr French—I think I explained that we did have some late submissions. We wanted to have the opportunity to talk to bodies that had made submissions and we will be doing that extremely shortly. That has been one of the principal factors leading to a slower track. Senator MACKAY—Is it possible to indicate the nature of the late submissions? Mr French—I cannot name them off the top of my head, but the submissions have come from a variety of business bodies which had already made submissions to the Dawson review. So it would be the sorts of bodies who had already made submissions. These submissions are giving us their latest views. Mr Murphy—The Dawson committee, in its consideration of hard-core cartels, said that it was introducing a criminal element into the Trade Practices Act and that it was a complex matter. It has taken some time to sort these issues out. It is a step in a different direction from the way trade practices legislation has operated in Australia. Notwithstanding the fact that it exists in other countries, it still has to be worked out how you would introduce it into the Trade Practices Act and also, as I think Dawson said, how you would introduce concepts of

ECONOMICS E 92 Senate—Legislation Thursday, 19 February 2004 pleadings and settlements in relation to criminal actions. So it is not a simple matter, but it is a priority for the government. The Treasurer has made it known that he is interested in the work that is being done and the Chairman of the ACCC has strongly supported the work dealing with hard-core cartels in relation to price fixing, so it is a matter that the government will consider. Senator MACKAY—Minister, I think this next question is to you. Is it likely that the government will introduce criminal sanctions for cartel behaviour as part of the trade practices amendment bill which is scheduled for introduction in the autumn sittings? Senator Coonan—As far as I know, there is a range of matters under consideration by the government, but I am not in a position to be able to provide any information to the committee at this time about the precise response. Senator MACKAY—Is there any indication of what matters will be dealt with in that legislation? Senator Coonan—Not until the government is in a position to provide a response. Senator MACKAY—In May 2001, the Commonwealth undertook to provide financial assistance to local councils affected by the HIH collapse on a one-on-one cost-sharing basis. What progress has been made in fulfilling this commitment? Ms Welch—The progress of the local government HIH assistance is that, at the moment, New South Wales has put some further considerations to the government to further change their offer, and the government are considering those changes. While New South Wales puts these further considerations to the government, the government are unable to finalise the offer. New South Wales is the state that has the most local councils that would potentially qualify under the offer. Senator MACKAY—So can I take it that no money has been expended to date? Ms Welch—That is correct. Mr Murphy—The latest complication has been the mergers of the councils in New South Wales. That has made it more difficult to work out entitlements. Senator MACKAY—How much does the Commonwealth expect to pay? Ms Welch—I cannot give you the exact number, but it is possibly about $20 million. It is a bit difficult to tell at this stage because some of the actions that are going on are being appealed at the moment. A lot of these actions are quite large. Until the outcome is known, it is difficult to tell how much. Senator MACKAY—But you can ballpark it to around $20 million? Ms Welch—Yes. Senator MACKAY—I will not hold you to that! Ms Welch—Thank you. Senator MACKAY—Is there any other reason for the delay, given that the heads of agreement were executed in October last year, other than it is complicated by the mergers in New South Wales?

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Ms Welch—No, the heads of agreement have not been executed. What happened was that New South Wales signed a draft heads of agreement, but, when they sent the signed draft back, it was sent back asking the government to make further changes to the agreement. Their agreement was conditional upon those further changes. So the government has not been in a position to be able to execute any agreement because of these conditions that New South Wales came back with. Senator MACKAY—Do you have any comment on the fact that the delay in honouring this commitment is costing some councils, I am advised, up to $19,000 in interest as they have had to take out loans to cover their liabilities? Ms Welch—I do not know what sort of comment you might be seeking. I know that the Treasury has been working very hard and the government is committed to getting this implemented as soon as possible. That has been our focus all the way through. We would like nothing more than to be able to start paying the local councils. Senator Coonan—That is correct, Senator. I think there have been about three or four suggested amendments coming from New South Wales. There was an additional policy issue that I have been asked to consider relating to the merger of councils that would otherwise have put some councils out of contention, because their assets would have exceeded the limit that had been applied. So there are some policy issues, but one of the difficulties is that the Commonwealth has been ready to conclude the arrangements and it is as if the ground keeps shifting. Every time we are about to sign, somebody comes up with yet another amendment. I think the most recent one that was brought to my attention was as recent as January. It is something that I know is important to councils and it is something that I will be in a position to conclude just as soon as these matters have been dealt with. Senator MACKAY—So what is the time line for the conclusion now? Ms Welch—At the moment there are two further proposals that have been put to the government since the draft heads of agreement was signed by New South Wales. Those proposals are being considered. It is difficult to have a time line when you do not know whether something else is going to come forward. Senator MACKAY—Assuming it does not? Ms Welch—The government has to consider the proposals that have been put forward. As Senator Coonan just said, one of them came forward only in the last few weeks. So the government is having to consider what the proposal is. Once that decision is made, hopefully we will be in a position to sign a heads of agreement. Once the heads of agreement is signed, the actual nuts and bolts of how the assistance will be delivered is going to have to be worked out as well. There has been a lot of work going on in the background to get that ready, but the way it is delivered will also depend upon the final agreement. Senator MACKAY—Given that the latest agreement was January, is there any type of deadline that government is working to, assuming that there are not any additional complicators that arise on the way? Ms Welch—There is no deadline. The government will consider this as quickly as possible, I am sure, and get an answer back to New South Wales.

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Senator MACKAY—I think that is it for output 3. CHAIR—Other than questions concerning the FTA? Senator MACKAY—That is right. Proceedings suspended from 3.55 p.m. to 4.20 p.m. CHAIR—These questions will be directed to outputs 1 and 3, concerning the free trade agreement. Senator Mackay? Senator MACKAY—Thank you, Chair. I think we were initially talking about some of the modelling that may or may not have been done on the free trade agreement. Did people get the gist of my questions previously? Mr Legg flicked them all to you guys. Dr Parkinson—We picked up a few of them but, in light of the desire to have us up here, I cannot say we have a comprehensive listing. So if you would indulge us we would be grateful for that. Senator MACKAY—Has any modelling been done with respect to the free trade agreement? Dr Parkinson—Modelling by Treasury? No. Senator MACKAY—Is it anticipated that Treasury will do any modelling or assessment? Dr Parkinson—That is a matter for the government to decide what it wants to do. You will note that the Department of Foreign Affairs and Trade is the responsible department. They have commissioned modelling in the past on the issue and, as I understand from what ministers have said publicly, the issue will be considered. Basically it is not an issue for us; it is a matter for the Department of Foreign Affairs and Trade and ministers to decide how they wish to proceed. Senator MACKAY—So Treasury has not been tasked with any further assessments, modelling or whatever other word may be used with respect to the free trade agreement? Dr Parkinson—No. Senator MACKAY—On this $4 billion figure, do you have any comment on Dr Stoeckel’s comments that there are a whole series of unders and overs that you have to look at with respect to this and recalculations to get any sensible number on the agreement, and that we really should get away from that $4 billion assessment? Dr Parkinson—I do not want to comment on Dr Stoeckel’s modelling or specifically what he said, although I would agree that the $4 billion number is in a sense a bit misleading. Let me explain why. The sorts of modelling that people can do are essentially static. They are assuming the structure of the economy does not change and then they are changing the costs of inputs; they are changing restrictions on exports and the like. They are doing that and they are getting a number out. That is fine as far as it goes but, as Mr Legg said earlier, the real benefits from trade liberalisation of this sort will be a function of the sorts of dynamic benefits that come over time—that is, how firms respond to opportunities that arise; in other words, how the structure of the economy evolves. If firms are prepared to go out and take advantage of the opportunities, if the changes to investment regimes result in different levels of investment, those things will ultimately have dynamic effects that are likely to be far more

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 95 interesting and important over time than the estimates that one gets from a static modelling exercise, whether it is by Dr Stoeckel or anyone else. Senator MACKAY—Why bother attempting to put a dollar figure on this sort of stuff at all? Dr Parkinson—That is a question that you would be far better off directing at the Department of Foreign Affairs and Trade than to the Treasury. We have not made any statement, public or otherwise. Senator MACKAY—So is it Treasury’s contention that it is almost impossible, given the fluidity and the non-static nature of the economy, to put a ballpark or dollar figure on this sort of stuff? Dr Parkinson—No. You can get an estimate and then you can change the assumptions of the model and get another estimate. Which of those estimates is right will depend upon your judgment. Which of those estimates is right in telling you about the static benefits of the economy will depend upon how accurately you think the model picks up the economy. All I am saying is that that is only part of the picture. It is the dynamic stuff that is going to be really interesting, and that comes from integrating your economy with the world’s largest, most dynamic, most competitive economy. If that leads to Australian firms being willing to go out and innovate faster, and find and exploit market niches that arise, you will get benefits that are quite different—much larger, one presumes—than what you would get from a static modelling exercise. Senator MACKAY—So Treasury is presumably in broad agreement with Dr Stoeckel that the use of the up to $4 billion should be desisted from? Dr Parkinson—No. I think Dr Stoeckel, a very respected economist, fully understands the caveats that surround those exercises. I do not think that he would be suggesting that the $4 billion is the definitive answer. $4 billion is what came out of the modelling exercise, given the assumptions that he made and the limitations of the model that he was able to use. Senator MACKAY—Has Treasury provided any advice to the Treasurer on the economic benefits of the free trade agreement? Dr Parkinson—You are asking me to disclose whether we provided advice to the minister, and that is outside of the realms of the questioning of the committee, I understand. Senator MACKAY—I am not actually asking you to provide the nature of the advice. I am simply asking you whether you provided advice to the Treasurer. Dr Parkinson—We provide advice to the Treasurer on lots of things. Senator MACKAY—But were you asked to provide specific advice to the Treasurer on this matter? CHAIR—Senator Mackay— Senator MACKAY—I do not think that is out of order. CHAIR—I think it is close to the line. I think any question which might tend to disclose the substance of the advice is objectionable.

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Senator MACKAY—I agree. That is not what I was asking. CHAIR—Your question was: did you provide advice about a particular matter? Senator MACKAY—That is right. CHAIR—I think that has generally been understood in estimates to fall on the wrong side of the line. Senator MACKAY—That is not my experience, but— Dr Parkinson—Perhaps I can help by acknowledging that we would always provide advice to the Treasurer on matters that fall within our portfolio responsibilities. Senator MACKAY—I imagine the answer is yes. That is fine. I respect the chair’s view in regard to that. Coming back to the estimate/assessment/modelling: surely Treasury has to make an estimate for the purposes of its own macroeconomic forecasts, or does it not? Dr Parkinson—We are dealing with an $800 billion economy. We are talking about a free trade agreement, the text of which we have not yet seen in its entirety, which the parliament has not yet considered and which neither the US Congress or the Australian parliament have yet passed. We would not even remotely consider attempting to work out the macroeconomic implications for our forecasts of the FTA at this stage. Senator MACKAY—One presumes that surely you will be in the future when all of these imponderables are revealed; would that be a fair assessment? Dr Parkinson—Once the imponderables are revealed you will have a situation where firms will have already started the adjustment process. So, for example, if a firm thinks that this is very beneficial to it and it believes that it can exploit the opportunities from day one, then as soon as it looks like parliament and Congress will pass the act the firm may well actually start making new investment decisions. If it does so—for example, if it changes its investment expectations—that will show up in the Australian Bureau of Statistics capital expenditure survey data, which we use to forecast investment. It would then be impossible for us to know to what extent any changes in investment expectations reflected an expectation about the benefits of the FTA to a particular firm as against other factors. So under any circumstances it would be very difficult for us, in terms of the way we forecast the macroeconomy, to identify the specific benefits of the FTA at a point in time. Let me be very clear: that is not to suggest that we do not think there are benefits. There are clearly benefits— there are going to be benefits to individual firms, to sectors and to the economy. But the question is really one of how you peel that onion to try and get an estimate from them once people start already behaving as if the FTA had passed. Senator MACKAY—Given the imponderables and the nebulous nature that seems to be being characterised here, will Treasury down the track ever really be able to estimate what the macro effects of the free trade agreement will have been? Dr Parkinson—It is like asking whether we can put a dollar value on particular structural reforms that occurred in the 1980s now. The answer is that it is very difficult. It is this static modelling issue again—you have got to go back and compare the structure of the economy then and the structure of the economy now. You would have to attribute all the changes in the structure of the economy to the policy changes that occurred. Would that be an appropriate

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 97 thing to do? Of course it would not. It is always very difficult—in fact I would go further and say it is very, very difficult to think about how you could do these things. Conceptually, you can think about— Senator MACKAY—Is it well nigh impossible? Dr Parkinson—No, but you have to be very clear in spelling out what assumptions you are making, and then reasonable people can differ over the assumptions. Senator MACKAY—The Treasurer did not seem to have a problem putting a dollar value on it. Dr Parkinson—As I understood it, his statement was referring to things that were already in the public domain. Senator MACKAY—The static issues that you were referring to? Dr Parkinson—The modelling that Dr Stoeckel and others have done. Senator MACKAY—Are you saying that it really will not be possible to determine what type of impact this will have had on the economy until 2½ decades have passed? Dr Parkinson—No. You will be able to see the benefits for particular firms and particular industries. To put a dollar estimate on those, based on macroeconomic modelling that is attempting to unpick the dynamic changes that have occurred in the economy as a result of it, will be very hard. Senator MACKAY—Were you here when I quoted a section of an article by Ross Gittins? Dr Parkinson—I heard you asking questions about Mr Gittins, but I did not hear exactly what you said. Senator MACKAY—In the Sydney Morning Herald on 11 February Ross Gittins wrote: Assuming the deal goes ahead, you’ll need a microscope to see the difference it makes to our economy—as the Howard Government’s own studies show. Do you have any comment on that? He did not put a 2½-decade time line on it. Dr Parkinson—I did not put a 2½-decade time line on it either. But it is an $800 billion economy. Remember, even if they were picking up all the benefits, these static modelling exercises would not tell you how much of that you would get in the first year, how much you would get in the second year, how much you would get in the third year and so on. They assume that the economy adjusts fully. What you are really interested in is the dynamic path of adjustment. You are really interested in not only those static benefits but also how the fact that the Australian economy is able to be more closely integrated with that innovative, dynamic and competitive US economy changes the behaviour of Australian firms. We will have to wait and see—sometimes those behavioural changes can occur very rapidly; other times they can occur very slowly. It is really a question of how quickly firms are willing to pick up the opportunities. Senator MACKAY—I understand what you are saying entirely. Dr Parkinson—All I am saying is that this is an $800 billion economy.

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Senator MACKAY—So, in terms of what the Treasurer will be forced to rely on, presumably he will be looking at modelling from Foreign Affairs and Trade rather than from his own department. Please correct me if that is a wrong assumption. Dr Parkinson—It is a matter for the government to decide what modelling it wishes to commission. I think you might be labouring under a misapprehension about what we do. The Treasury do not attempt to model the macro economy by looking at the impact of particular developments on particular industries. At one level we can do that, but we are macro- economic modellers; we are not trying to do a static model which breaks the economy up into individual industries and asks how the impact of a particular policy change affects that industry. That is not something that we do. Senator MACKAY—I understand what you are saying. It is not a sectoral disaggregation; I understand that. Dr Parkinson—There is no sectoral disaggregation in the production side of anything that we are estimating. Senator MACKAY—But presumably you have to have a view with respect to the macro economy. Dr Parkinson—Absolutely. Senator MACKAY—That is what I am asking about. I am asking about the prospective view in terms of the macro economy and the impact that the free trade agreement will have on that—probably not in the next financial year but maybe the one other after that, or the one after that or the one after that. Dr Parkinson—We will not make any decision about what we think the impact will be until we actually see what it is that parliament and congress pass. As I said earlier, we have not seen the text of the agreement. Senator MACKAY—Other than the parts that Mr Legg was responsible for negotiating. Dr Parkinson—Yes. Senator MACKAY—ACIL Consulting has suggested that the impact on Australia could be marginally negative, and the IMF earlier this year also suggested that a free trade agreement with the US could have a negative impact on Australia. Is that possible, in your view? Dr Parkinson—I will invite Dr Kennedy to respond to that. Dr Kennedy—The difference in the modelling results in part reflects what Dr Parkinson was talking about before. Essentially, when you make different assumptions about productivity or how exports are likely to respond to price changes, you will get different results. So the types of differences you are seeing in those models reflect the underlying assumptions that the model builders are making. Senator MACKAY—So you can plug in any set of variables and get any set of results. Is that what you are saying?

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Dr Kennedy—The point of the modelling, as Dr Parkinson said, is to make it transparent so that reasonable people can discuss your assumptions and make a decision about how reasonable they feel they are. Senator MACKAY—What you are saying is that, in terms of the static economy that we have been discussing, depending on what set of variables you use in the modelling, that would determine what kind of outcome you would get. Is that fair? Dr Parkinson—I might just add some comments to that. What you are looking at now is a technology problem, in one sense. As Mr Legg said earlier this afternoon, the benefits are likely to come in the sort of non-sexy areas. What is everybody focusing on? They are focusing on sugar, dairy and whatever. The models that people use to undertake these sorts of assessments are invariably around trade in goods. But Mr Legg was saying that the things where the great benefits are likely to come from are in services or procurement. We believe those things are not accurately and adequately reflected in the sorts of models that are available. That is why I was saying earlier that, whatever benefit you get out of the static exercise, whether it is Dr Stoeckel’s $4 billion or whether you change assumptions and come up with another number, it is just a number. The suite of benefits is going to be broader than that because they are going to come about through the dynamic responses to these other things which we believe are not being accurately or adequately reflected in the development of models. Senator MACKAY—How do you measure these other things? Dr Parkinson—When people who are better modellers than us develop the right tools for us to think about and use. Senator MACKAY—Is it possible to measure these other things? Dr Parkinson—Economics is an evolving area, as are physics and biology. We will ultimately always be able to do better than we do today. Senator MACKAY—You seem to be talking about behavioural science. Dr Parkinson—Behavioural economics is actually a fairly important field. In fact, if you look at it, the most recent Nobel prize winners were in the field of behavioural economics. Senator MACKAY—I saw that. I must admit, I am not familiar with the work, but I did note that. Are you suggesting that the benefits would exceed the model estimates? Given the model estimates, with a static economy and the list of variables that go in, plus the sorts of things that you are talking about, could there be an exceeding? Dr Parkinson—My view is that you could run static models and you will get a number. You could change the assumption of those static models and you will get another number, or you could use a different static model. Which of those is the most accurate number of the static benefits will depend upon your judgment about which of those is the most accurate in picking up the fine detail of the free trade agreement and the fine detail of the economy. But whatever number you decide on is purely the static benefits. I am suggesting that the more interesting thing will be: how do we adapt; how do we respond dynamically over time to the opportunities that are being raised? That will turn on the behavioural responses that we see of

ECONOMICS E 100 Senate—Legislation Thursday, 19 February 2004 firms—not only in Australia but also in the United States and elsewhere—and it will also turn on the willingness and capacity to exploit, as Mr Legg referred to them, the non-sexy areas. Senator MACKAY—Thank you for that. Do you have any comment on the impact on Australia’s trade deficit with the US? Dr Parkinson—No, for all of the reasons I have talked about previously. Without wanting to judge what might have motivated that question, if one thinks about the trade deficit one should not use that as the metric of benefit. It is a common mistake for people to believe that exports are good and imports are bad. That is not right. That is a very mercantilist view of the world. What is really important is the overall benefits to Australian society—the wellbeing of the Australian public—and the trade deficit, per se, do not tell you anything about that. Senator MACKAY—At the risk of being mercantilist, do you think it will have an impact on the trade deficit with the US? Dr Parkinson—It will undoubtedly have an impact on trade. It will boost exports and it will boost imports; there will be exports and imports of goods and services. It will change investment. It will affect not only the trade balance but also the balance of goods and services and, therefore, it will impact on both the current account and the capital account. Senator MACKAY—I understand that, but do you think it is going to be negative or positive, or do you have no idea? Dr Parkinson—As I said, everything is going to depend on the capacity and willingness of Australian firms to exploit the opportunities being offered to them. I personally have great faith in the Australian industry to adapt. Senator MACKAY—A report prepared for the America-Australia Free Trade Agreement Coalition suggests that US exports would increase more than imports. It states: ... US exports to Australia would increase by $1.9 billion— I do not know what set of variables they are using— compared to an increase in imports from Australia of $1.2 billion. Have you not heard of that? Dr Parkinson—I have not seen the report. I have seen reference to it, but we have not seen the material. Senator MACKAY—Is it possible for you to look at the material and provide us with an answer on notice? Dr Parkinson—We do not know whether we can get access to the material. Senator MACKAY—If you can get access to the material, could you take the question on notice? Dr Parkinson—If we can get access to the material, we will look at it. People can throw around numbers very easily—everybody has got a number that they can throw around—but as to whether that tells you anything—

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Senator MACKAY—I understand that, but I am specifically asking: if you can get access to the report—and I suggest you might be able to—could you take it on notice to provide some comment on it for me. Dr Parkinson—We will take it on notice. Senator MACKAY—Wouldn’t Treasury need to factor in any increase in the trade deficit when forecasting the possible impact on Australia’s current account deficit? This is all terribly nebulous, I have to say. Dr Parkinson—Undoubtedly. Senator MACKAY—If you listen to the government, it is not quite as nebulous as you are making out. Dr Parkinson—Undoubtedly we would have to do that when we think about the current account deficit when we are forecasting. The current account deficit is the gap between national saving and national investment. But, clearly, when you add up the current account deficit, you are going to add up the balance of trade and the net income balance and that will give you your current account balance. So, invariably, when we are doing forecasts, we have estimates of exports and imports in goods and services and you would have an implicit balance of trade estimate. Senator MACKAY—So at what point would you factor in the free trade agreement in respect of those forecasts? Dr Parkinson—I am definitely not going to start doing it before I can actually see it. Senator MACKAY—I understand that it will obviously not be now and will probably not be in the next financial year. Dr Parkinson—You would basically try and do something once it has been passed and if we conclude that there is enough information here for us to be able to make sensible adjustments to the aggregates at the level which we deal with them. Remember, we are not estimating the benefits for a particular industry; we are estimating for the economy as a whole. Senator MACKAY—That is right. So you will need a set of empirical data. You referred to the ABS yourself, for example, as a conduit of empirical data which you may use to assist you in terms of forecasts of this nature. At what point would the empirical data be substantive enough to assist you in forecasts with respect to the current account deficit? Dr Parkinson—Let me be clear. Once we know what it is we are dealing with and it has been passed, that would be the time conceptually you would attempt to build it into the forecasting process. But you would then have to make judgments about how quickly people would be able to exploit the opportunities. You would only be doing that, in a sense, in a very aggregative manner. Given the way we forecast, we would not be able to go out and say, ‘This is the way in which the motor vehicle industry will respond, so we should factor in this change to manufactured exports.’ We just do not deal on that level of sectoral disaggregation.

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Senator MACKAY—Wouldn’t you be able to look at it once the full agreement has been made public rather than once it has been passed? Why would you wait until it has been passed before you are able to provide some analysis, passed or otherwise? Dr Parkinson—You asked me whether we would then factor it into the forecast. I would not factor it into the forecast unless you want to tell me that parliament is going to pass the bill and Congress is going to pass it. I would not factor anything into the forecast until we got to that point. It is similar to the fact that you might have a judgment that the Reserve Bank is going to change monetary policy sometime over the next six months. As a technical assumption, we assume no change in interest rates, because we cannot. We are not actually the decision makers there and we cannot make that assumption. Once parliament changes legislation, whether it is in the form of delivering a tax cut or passing the FTA or something else, that is the time we would take those things into account in preparing the official forecast. Senator Coonan—It might just help you to know that I think, on the last look at it, it required about eight different pieces of legislation to be either amended or passed. Bitter experience suggests that some bills, at least, tend to get a haircut in the Senate. Senator MACKAY—I appreciate that—thank you, Minister. Once the free trade agreement has been made public, what will Treasury then do with it—nothing? Will it wait until the eight bits of enabling legislation have been carried or— Dr Parkinson—You are asking what Treasury will do about it in a macroeconomic modelling sense? Senator MACKAY—Yes. Dr Parkinson—We will wait until— Senator MACKAY—You will wait. You will not do any modelling, assessments or whatever until such time as it is determined—as the minister says—whether the eight pieces of enabling legislation have been carried or otherwise, and the US Congress has voted on it. Dr Parkinson—That is correct, in terms of putting it into the government’s official forecasts. Senator MACKAY—So here, again, I presume that the Treasurer will be relying on the Department of Foreign Affairs and Trade. Maybe the minister could answer that—I do not know. Dr Parkinson—The Treasurer will make a judgment about what he wants to rely on. We will advise him on all matters that are pertinent from our perspective, but it is ultimately the government’s decision about what modelling it chooses to do on this issue. Let me go back to the point I made earlier: the really interesting and valuable outcomes from this are unlikely to be captured by the sorts of modelling that can be sensibly done. In part, that is because the barriers to trade in goods and services between Australia and New Zealand on the one hand and developed economies and the US on the other are so low that removing the remaining barriers is unlikely to generate massive static benefits. The benefits will come from how Australian firms respond to those opportunities—whether or not they are able to get out there and integrate more closely and, as a result, become more innovative and dynamic, and whether our markets become more competitive. I do not want to harp on this point, but the

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 103 benefits of trade liberalisation come to the liberaliser. The great benefits we got from tariff reductions during the 1980s and the early part of the 1990s were not because we negotiated those away with someone else but because we unilaterally took them away. Senator MACKAY—Thank you for that. I will just make the point one last time that the government has claimed that the free trade agreement is of major national economic benefit. I will make the observation—and give you the chance to correct me—that it does not seem that you, as the government’s main economic adviser, are able to back up the government’s claim of economic benefit. In fact, you have not even seen the full agreement. Dr Parkinson—Let me agree with you: we have not yet seen the full agreement. But let me go back to the point I made earlier: there are model estimates out there— Senator MACKAY—Based on static economic modelling. Dr Parkinson—and, as I have said interminably over the last hour, the benefits that are really interesting are going to be the dynamic benefits. They will show up over a very long period and they will show up through changes in the structure of the Australian economy, through changes in investment patterns and through changes in legal certainty—all the sorts of things that Mr Legg referred to when you were discussing the issue with him earlier. Senator MACKAY—But you have effectively dismissed previous modelling as looking at the static economy with a set of variables— Dr Parkinson—No. I did not dismiss previous modelling; I said previous modelling gives you a number, and that is fine as far as it goes, but, if you really want to get a comprehensive perception of the benefits, you have to have an appreciation of the dynamics. The models cannot give you that. Senator MACKAY—And, as you said, I think, it does depend on what variables are plugged in. Dr Parkinson—In any particular model, yes—and that is as Dr Kennedy said: the important thing is to be transparent about the assumptions you are making and let reasonable people make an assessment about both those assumptions and whether or not the model is sufficiently rich to pick up the detail of the FTA and the structure of the economy. Dr Kennedy—Can I just make a further comment about the modelling. Some of the modelling can capture how things might evolve through time, but that does not mean it is dynamic in the sense that Dr Parkinson is referring to. It has to assume that the structure of the economy is largely unchanged. That is why the trade modelling is quite different to the forecasting modelling that we might do. In the trade modelling you are looking at differences from a world, an assumed world or a baseline; in forecasting we have to forecast from wherever the economy currently is and then go forward. So determining what effect the agreement might be having on the economy is very difficult because we are not holding everything constant—which is what you are doing in modelling: you are holding everything else constant. We have to allow for change in all those things that are changing, to get the best forecast we can. Senator MACKAY—I understand that extremely well; I understand exactly what you are saying. I make the observation that others seem to be estimating the economic benefits of this,

ECONOMICS E 104 Senate—Legislation Thursday, 19 February 2004 but Treasury is not and, presumably, will not be able to until such time as it has seen the agreement, it has been through parliament and it has been through Congress. Then Treasury will make an assessment, one assumes. Is that right? Dr Parkinson—When you say ‘make an assessment’, we will then factor it in to the forecasting process. Senator MACKAY—I am advised that the enabling legislation cannot be changed in the Senate, because that will mean the agreement will not come into effect. So, as with all agreements, we are looking at a package. Would it be correct to say that there is no uncertainty there? Senator Coonan—Obviously, you cannot depart much from an agreement, but how you implement an agreement and what you need to change in existing legislation is a different matter. Some of the eight pieces I was talking about involve amending existing laws and others involve introducing new enabling legislation. I think it would be correct to say that there is not much you can change. But that does not mean to say that the way it is implemented might not be the subject of some amendment. Senator MACKAY—That is it for the free trade agreement. I want to ask about MYEFO. To contextualise it for you, page 13 states: Household consumption is forecast to increase by 4½ per cent in 2003-04, an upward revision from the 3¼ per cent forecast in the 2003-04 Budget. Underpinning the upward revisions are stronger-than- expected gains in household wealth, largely due to higher house prices, and increased household borrowing. What is the current level of household savings? Dr Hagan—As measured in the national accounts, the current number is a negative number. Senator MACKAY—So in layperson’s terms, households are spending more than they are earning. Dr Hagan—I would be careful about how I interpreted the savings ratio number, partly because it is a residual. It is calculated as a residual in the national accounts. Experience has shown that it can actually be revised in both directions. I think we have an earlier example that Dr Parkinson gave at the last hearings. He made the point that something that was negative became positive in the case of the household savings ratio. So how we interpret that is problematic to some extent, and that is a point that we have made previously. Senator MACKAY—As a layperson, what is the savings ratio? Is it not savings relative to income? Dr Hagan—The savings ratio is the number you get after you have subtracted the measured expenditure of households. The trouble is that we are trying to measure expenditure and output. Each quarter—and, obviously, annually—the ABS stresses that there are measurement errors in the broad aggregates that it publishes and it refines those numbers over time. What that means is that a number that is derived by taking two inaccurate numbers from each other is inaccurate itself. It has an inaccuracy that is coming from two directions. Senator MACKAY—Yes.

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Dr Gruen—There is another conceptual reason why it is tricky to derive implications from the household savings ratio which is particularly relevant at the moment. As Dr Hagan said, you are subtracting expenditure from income, but what you are not taking account of are the capital gains that households have been earning from the fact that their housing is getting more valuable. As the household savings ratio is calculated, that is not part of household income, even though it is a substantial part of household income in economic terms. Senator MACKAY—Thanks for that. How often has the level of household saving been negative in the past? When has it been negative previously? Dr Parkinson—It has been negative previously, as Dr Hagan alluded to. I think it was at the last hearings that we made the point to Senator Sherry that if you have a look at a chart of household savings ratios—the data that was available up to 1992, 1994, 1996 and so on— what you tend to see is that the most recent data suggests that the household savings ratio is falling dramatically. There have been a number of times when the household savings ratio in the most recent quarter has been negative. In actual fact, when you look at history you find that that trend decline has actually been eliminated. You often have the picture that the last period looks like it is in dramatic decline and sometimes can be negative, but in the future, when the ABS has a more complete estimate of both income and outlays, that goes away. As Dr Hagan said, it is a function of the fact that we are not picking up necessarily all of the information at the most recent time. Senator MACKAY—We can come to that a little later in my brief. Dr Hagan—Can I just elaborate on the example I gave about how much things can move? Senator MACKAY—Sure. Dr Hagan—This is an example from previous hearings. In the March quarter of 1996, the initial estimate of household saving was 0.1 per cent. It then was revised up to 5.6 per cent, which is a pretty substantial revision. So reading the last number, as Dr Parkinson said, is not enough. Time gives us a better perspective on what the actual household savings ratio is. Senator MACKAY—So would you regard the current situation as comparable to, say, 1996? Dr Hagan—I do not know that I would get into comparable positions. The point I would make about how I interpret the state of household accounts is that I would be picking up what Dr Gruen referred to, which is starting to look at their net asset position as well, which reflects their wealth—how their wealth is accumulating—and the capital gains that are effectively income. And households may choose to, in a sense, bank that income as a gain or they may choose to spend it. But in terms of their actual welfare and wellbeing, the fact that their wealth is increasing is an improvement in their welfare. That may mean that the pressure on them to save is reduced as well. That is trying to understand how households may actually be behaving. Senator MACKAY—I appreciate that. Has there been a period in our history with comparable rates of household saving? Dr Hagan—That is quite an open-ended question. How would I make the comparison?

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Senator MACKAY—I guess you would make a straight comparison, given that I do understand the variables you are talking about which we will come to later. Let me ask another question that may be a bit clearer. Have these saving rates been this low before? Does that make it any clearer? I think that is pretty straightforward. I cannot get much clearer than that. Dr Hagan—I defer to someone who has better knowledge of the data than I have. Dr Gruen—I am not sure that we have the data with us. I am not sure that I know but, to go back to the point that has been made by both Dr Parkinson and Dr Hagan, the saving ratio on several previous quarters has been negative when first released and subsequently has become positive. Senator MACKAY—I heard that, but does anyone know whether it has been this low? Dr Gruen—On first release? Senator MACKAY—Yes. Dr Gruen—That I do not know. Dr Parkinson—We will have to take that on notice. Senator MACKAY—Okay. Dr Gruen—One largely keeps the information that is the best current information about previous quarters rather than the first release, though you can keep the first releases. Senator MACKAY—Of course. Do you have a dollar estimate of aggregate household debt? Dr Parkinson—We do not off the top of our heads. Dr Hagan—I think we may have provided it in an answer to a question on notice from the previous estimates. Senator MACKAY—Okay. I was not here, so if anybody has that, I would appreciate it. Dr Parkinson—I do not have with me the questions on notice that we took. We did undertake to provide that. If it is not there then we will get it for you. Senator MACKAY—There is nobody from the committee here to advise whether that has been provided. Dr Hagan—May I provide you with the information we do have? The level of debt held by households was $477 billion in the June quarter of 2003 and $122 billion in the June quarter of 1993. The household debt servicing ratio was seven per cent in the June quarter of 2003 and 4.7 per cent in the June quarter of 1993. The debt servicing ratio peaked at 8.4 per cent in the September quarter of 1989. Senator MACKAY—Given a negative household saving rate and a high level of household debt, wouldn’t the economy be particularly susceptible to an increase in interest rates at the moment? Dr Hagan—I will start with the first part of the answer and Dr Gruen might like to comment further. Whilst debt has increased, so have assets, so that the net asset position of

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 107 households has actually improved. In terms of their debt to asset ratio, households are holding $6 of assets to every dollar of debt and about $2 of financial assets to every dollar of debt. Senator MACKAY—That is not actually what I asked, though, is it? Didn’t I ask: given a negative household saving rate and a high level of household debt, wouldn’t the economy be particularly susceptible to an increase in interest rates at the moment—irrespective of how much wealth is tied up in stock? Dr Gruen—If I could add to the answer that Dr Hagan gave, I think it is undeniable that, given the increase in interest rates, if you have a higher stock of debt to income that means that those people with the debt will have their interest payments go up by a higher dollar value. I think almost precisely this question was asked of the Governor of the Reserve Bank at one of the parliamentary hearings. He gave the answer—which I would agree with—that that part of the interest sensitivity of the economy has clearly gone up but it is not the only part of the economy that is interest sensitive, it is simply one part of it. Senator MACKAY—So, if the economy is largely fuelled by consumption, wouldn’t this take a hit if interest rates increased? Dr Hagan—I am talking hypothetically here, but you would have to take account of what else is going on at the same time. Usually when interest rates go up it is because the economy is performing strongly. Senator Coonan—It is a positive, yes. Dr Parkinson—You do not change monetary policy in a vacuum. If the economy is growing at or above trend and you were concerned that inflationary pressures were emerging—wage pressures were emerging—and you tightened interest rates, it is not at all clear that households in aggregate would be taking a hit. On the other hand, if you had an economy which was in recession and where there was falling employment, weak wages or non-existent wage growth and you raised interest rates, of course you would. Senator MACKAY—I am actually talking about now. I understand entirely what you are saying. Dr Parkinson—Today we have an economy that is growing at or around its potential growth rate and where unemployment is down to about 5¾ per cent, and we know that households are not having any difficulty servicing their debt in aggregate. So it is indisputable that, if you raise interest rates, people have to pay more in interest servicing costs, but the macroeconomic implications of that cannot be looked at in isolation from the state of the economy. Senator MACKAY—Thank you. Now I understand. So Treasury cannot confirm that an increase in interest rates would hurt consumption? Dr Parkinson—No, I did not say that. You are putting words in my mouth that are not remotely close to what I said. Senator MACKAY—I am giving you an opportunity to correct it. Dr Parkinson—If you raised interest rates, everything else being equal, people have less income and that will impact on consumption. Everything else is not equal. If you raised

ECONOMICS E 108 Senate—Legislation Thursday, 19 February 2004 interest rates in the context of an economy that was blowing its head off, with massive wage growth, it is not at all clear that consumption would fall from where it actually is; it would fall from where it would otherwise have been—so you would need to know what your counter- factual is. But if you are asking the question: ‘Would raising interest rates today impact on household consumption?’ the answer is yes. Senator MACKAY—That is fine. Did you say that households are not having a problem servicing their debt? Dr Parkinson—In an aggregate sense. It is the point that Dr Gruen and Dr Hagan were making earlier, that household servicing ratios are about seven per cent. Dr Hagan—It is between seven and eight. Dr Parkinson—Yes. That is an aggregate. That is not to say that any particular individual— Senator MACKAY—Yes, I understand. On 8 December last year, before the House of Representatives Standing Committee on Economics, Finance and Public Administration, the Reserve Bank Governor stated: An economy that is growing at six per cent in nominal terms cannot have credit growing at 15 per cent, and it cannot have household credit growing at 22 per cent. Something has to give at some time. Does Treasury share this view? Dr Parkinson—In abstract, or are you asking whether I agree with the governor? Senator MACKAY—I asked: does Treasury share the view of the governor? Dr Parkinson—I would never disagree with the governor. Senator MACKAY—Let us say it was me saying that—would you agree with me? Dr Parkinson—I think you would find that you are talking about an economy where, over time, pressures would emerge and that you would need to adjust policy. The question is when you would need to adjust policy, and by how much. Senator MACKAY—So something has to give at some time? Dr Parkinson—It pretty much stands to reason if household credit growth is growing at four times nominal GDP. Senator MACKAY—What has to give? Are you talking about higher interest rates? Dr Parkinson—Think about it. Ultimately what it means is that the household debt to income ratio becomes explosive—in other words, it spirals out of control. Households would ultimately be unable to service their debt. The question is: when does that become a problem and what do you do about it? Senator Conroy and I have had a long history of discussion on this particular issue. Senator MACKAY—And I am sure you will again. Dr Parkinson—I am sure I will, and I look forward to it. Senator Conroy and I have known one another for many years. Indeed, as much as I am enjoying your presence today, I am missing Senator Conroy.

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Senator MACKAY—Are you? I am crushed! Senator Coonan—That is not to say that you are not very welcome, Senator Mackay. Senator MACKAY—Thank you, Minister. He is off torturing Trade. I suspect you will see him at the budget estimates. Does Treasury accept that there is a risk of more moderate growth and possibly even a decline in housing prices in some areas? Dr Hagan—I think one way of approaching that is to look at what the data is showing at the moment, and at the moment we are seeing some decline. So it is not an expectation; depending on which part of the housing sector you are looking at— Senator MACKAY—I appreciate that. If people are increasing consumption on the basis of housing wealth—and this comes back to something we were talking about earlier—and that housing wealth is illusory, isn’t that a serious concern? Dr Hagan—I might modify to some extent your question. Are you arguing that housing wealth is illusory here, that the actual growth in the wealth is going to slow down or that we are going to see a collapse in housing wealth? Senator MACKAY—The fact that you have a house that is worth a lot of money doesn’t help you on a day-to-day basis, does it? Dr Hagan—It can. It can actually help me borrow money. Senator MACKAY—That is right. Dr Hagan—And if it is worth more then I have got more— Senator MACKAY—So people are increasing consumption on the basis of their housing wealth, but they are never going to sell their house, are they? What I am saying is that existing housing wealth is illusory in some areas. Falling prices would suggest it is, for example. Dr Hagan—At some point people may in fact be going to sell their houses, but they might not be going to sell them tomorrow. Also a large part of the growth in the housing market has been in investment housing, which is to produce an income stream. Senator MACKAY—But not necessarily for the average punter. Investment housing is not a major increase in income for them. Senator Coonan—It is huge. Senator MACKAY—Maybe for you! Dr Parkinson—The tax commissioner is in the room next door, and I am sure that when he comes in he will be able to talk about this issue more than I can. My recollection is that there is something in excess of a million households that have investment properties. Senator MACKAY—I know that. That is fine for them. Dr Parkinson—Some of those million clearly are not your average punter, but I think we would be surprised by— Senator MACKAY—But not everybody is benefiting from the investment. Dr Parkinson—Of course it is not everybody. I can say personally that it is most definitely not everybody.

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Senator MACKAY—I think we are really getting into a semantic game here. If you are not an investor, say— Dr Parkinson—If I am not an investor and my wealth has gone up because of the value of my house, the evidence seems to be that I still act by going out and spending some of that wealth. Senator MACKAY—Precisely. Dr Parkinson—The way you could think about it in economic theory terms is that you are basically looking at your lifetime wealth, house prices have gone up, you believe therefore you are going to be wealthier over the course of your lifetime, and so what you do is reduce saving today—in other words, you channel some of your saving into consumption. It may well be that what you do is withdraw some of the equity from your existing mortgage and use that for consumption today. They are decisions that particular individuals have to make based on their own financial circumstances. Senator MACKAY—So you would not contend that people are currently overspending? Dr Parkinson—No. This goes particularly to the point that Senator Conroy and I have discussed numerous times. Implicit in that question is that there is somehow a level of household debt to income that is good and once you deviate from that everything is bad. I do not know what level of household debt to income you are comfortable with, but I know I have got a level that I am comfortable with, and everybody else will have one. It is not for us to say what is good or bad. The real issue is whether, from a macroeconomic perspective, households are in a position where they can service that debt without being excessively sensitive to changes in economic circumstances. That goes back to the question of whether we are seeing people in distress now—we are not. Are people more sensitive to interest rate increases than they were previously? To some extent, yes. That is about as far as we can go. Dr Hagan—There is also a bit of evidence to suggest that households are reasonably efficient at managing their risks, on average. Senator MACKAY—Sure. Dr Hagan—For example, we have seen households adjust their debt servicing ratios fairly quickly in response to changing circumstances. I think some of the analysis of the HILDA data set suggests that in fact the people who leverage themselves most highly are the people best able to service highly leveraged loans, for example. We can misunderstand what is going on if we think of households as being a homogenous group unable to make judgments about how to manage the risk around them and potentially underestimate their ability to adapt to changing economic circumstances as well. The evidence suggests they do adapt. Senator MACKAY—What if housing wealth did decline? What would be the key risk to the economy then? Dr Hagan—There are a number of channels that one would want to trace back and think about. We have actually mentioned one of them in the MYEFO, setting out the risks. This is not where housing prices decline, but if there is a change in the expectations about the housing market households may decide to consolidate their accounts. If they do that, it means they may moderate consumption expenditure, and you could see that that could have a

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 111 negative effect on economic growth. Another channel that you might want to look at is this: if there were decline in housing prices you would be starting to talk about a fairly substantial change in the housing market and you might see a change in the level of activity, which would have flow-through effects into employment levels, for example, with the consequent effects of that. It seems to me that there are two big channels that you would want to think about. Senator MACKAY—That is good. Do you think that there is excessive speculative behaviour in some segments of the housing market at the moment? Dr Parkinson—The terminology I used previously, to the amusement of other senators, is that there are pockets of speculative excess. Senator MACKAY—Was that with Senator Conroy? Dr Parkinson—And Senator Sherry. I have no reason to move away from that. There are pockets of speculative excess. I have also indicated that there are parts of the housing market that you would not get me touching with a 40-foot barge pole. Senator MACKAY—Yes, I heard that last time. I took note, actually. Dr Parkinson—I have not changed my view. You only have to pick up the Sydney and Melbourne papers to see the sorts of areas to which we were implicitly referring having the experience that we were worrying about. Senator MACKAY—As I recollect, you do not believe that there is a housing bubble. You will exhort me to define that more particularly. Dr Parkinson—I will exhort you to define that, but I will be very happy to agree with you that there are pockets of speculative excess. Senator MACKAY—What is a housing bubble, in your view? Or do you think that is an inaccurate description? Dr Parkinson—I must admit I have not thought about attempting to better define that issue in the time since the last Senate estimates hearing. I do not have anything to add to what I said at that time. Senator MACKAY—Has Treasury dealt with these types of circumstances, otherwise known as bubbles, in markets before? Dr Parkinson—Australia has seen periods of asset price increase. You only have to go back to the late 80s and overbuilding in the office sector. Clearly, you have seen overbuilding in some parts of the housing market. Senator MACKAY—Do you think that the current situation is in any way comparable? Dr Parkinson—I think it depends on what you mean by comparable, and I am not trying to be cute here. If you go back to that period of office overbuilding, there was a generic problem of corporate balance sheets being stretched and households facing 18 per cent-plus interest rates on home mortgages. There is no evidence at the moment that the corporate sector is in any distress and there is no sense that the corporate balance sheets are a potential problem. As Drs Hagan and Gruen mentioned earlier, household balance sheets look like they have not changed much. Yes, household debt has risen but household assets have risen. The

ECONOMICS E 112 Senate—Legislation Thursday, 19 February 2004 important thing is that for every dollar of debt there is $6 of assets in aggregate, of which two of those are financial assets and, in a sense, more easily liquidatable. Senator MACKAY—Let me attempt to define it a bit better. Is excessive asset prices fuelled by ongoing expectations of further rises rather than fundamentals a fair definition of bubble? Dr Parkinson—That would be one definition of a bubble. Senator MACKAY—Let us move to page 14 of MYEFO. It says that the unemployment rate is expected to remain at around or a little below 5.75 per cent over the forecast horizon. To what extent does Treasury believe that current policy settings will reduce unemployment over the forward estimates? Dr Hagan—This relates back to the earlier discussion on the free trade agreement. We do not necessarily think that policy settings per se are driving these numbers. If you could refine the question a little I might be able to help you a bit more. Senator MACKAY—Do you believe that unemployment will fall any further? Dr Hagan—At the moment, with our forecast, we have strong growth at about trend— about potential—in the economy; we have the labour market growing fairly steadily as well; participation rates in the labour market are not moving around very much; we have historically low interest rates; and we have no signs of systemic inflation in our forecast horizon at the moment. That suggests that the conditions are good for job creation to continue, but we are about to enter a new forecasting round and we are going to revisit and re-evaluate the data. There will be a national accounts release in early March—that is when we get to have another look. Dr Parkinson—Let me add to that. If you are asking this question in respect of the specifics of the forecast then, as Dr Hagan has said, our forecasting horizon is basically the rest of this year and next year. What we have said in the MYEFO we will have to wait and see when we review the forecast. If you are asking the question, ‘Can Australia reduce its unemployment rate from where it is today?’ the answer is indisputably yes. I will go back to a comment that was made by a former Secretary to the Treasury, which is that a country chooses its own unemployment rate. Australia has chosen to have an unemployment rate that I personally find too high. It is within the capacity of parliament to take decisions about particular policies that will allow us to lower our unemployment rate. If we are serious about wanting to lower our unemployment rate, there are a set of policies that we can pursue. Senator MACKAY—Dr Hagan, do you think there will be no reduction in unemployment despite a slightly falling participation rate? Do you think that will impact on the unemployment rate at all? I do appreciate what you are saying, Dr Parkinson. Dr Hagan—Are you asking what the impact of a falling participation rate is? Senator MACKAY—Do you think there will be no reduction in unemployment, despite this slightly falling participation rate? Dr Hagan—There is the potential for unemployment to fall further. I cannot go much beyond what we have in the MYEFO at this point. Just to restate what I said, the prospects going forward are pretty good. Things like participation rates do move around a bit and can

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 113 affect the actual number. I think the question is: what is the general wellbeing of the Australian public in terms of employment growth? If it is strong, that is a good thing. Senator MACKAY—Okay. Just coming back to your comments, Dr Parkinson, in terms of the levers you were alluding to—although you did not use that term—would reducing minimum wages reduce unemployment, in your view? Dr Parkinson—It would be one way of addressing it, but the real issue is what sort of labour market you want. Reducing minimum wages per se would only be one element of a range of possible policies that you could pursue. Greater flexibility, greater incentives for firms to pursue productivity gains and innovate—coming through a more competitive environment and giving people appropriate incentives to accumulate skills, and giving firms and the labour market a greater capacity to reward those skills—would have benefits. There are a range of things we can do to both increase participation and increase productivity, and, if we are prepared to bite the bullet on those issues, we can actually lower unemployment in a sustainable fashion. Senator MACKAY—What about things like in-work benefits, such as tax credits, improved work incentives and that sort of thing? Dr Parkinson—I do not want to go to any particular policy measure. Senator MACKAY—Well, you have. Dr Parkinson—No, you raised the issue of minimum wages. I did not say that that would be my preferred way of doing it; I said it would have an impact. There is a range of ways in which Australia could address the challenge of lowering unemployment if it wished to do so. We have chosen, through the policies we have pursued, to have a higher rate of unemployment than we could otherwise have. Senator MACKAY—I understand. Thank you for that. What is Treasury’s view of current and looming wage pressures in the economy? Are there any specific areas of concern? Dr Hagan—I am not sure that I would refer to areas of concern. In terms of looking at wage pressures in the economy, we do not see any systemic wage pressures that are likely to cause any problems at the moment. I think the largest wage increases in the last release came out of the public sector. Our business liaison program suggests that, whilst firms are paying increased wages, they are also finding productivity offsets. Senator MACKAY—Are there any areas of concern in sectors or industry? Dr Hagan—Again, I do not know that ‘concern’ is the right word to describe it. I think the building sector has one of the higher wage increase figures at the moment, but that is hardly surprising given the level of activity there. In fact, given previous history, another way to think about that is that the increases in that sector are actually low, given the level of activity too. Senator MACKAY—Yes, in terms of the base. Dr Parkinson—We do not have it with us, but we do a write-up on the business liaison program and publish that periodically in the Economic Roundup. There may well be more detail in that than we can just recall off the tops of our heads.

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Senator MACKAY—Thank you for that; that would be most useful. Dr Hagan—I have found the section that refers to wage increases. We found in business liaison that expectations of wage increases of around three per cent to four per cent were anticipated by most contacts—this is published in the Roundup—but that was not picked up as being a significant problem. Senator MACKAY—That is an aggregate figure. I was asking about any areas of concern. I think you have pretty much answered that. Dr Hagan—The Roundup says: Contacts indicated that they were not facing general skills shortages, with the exception of the construction industry and the health sector. Senator MACKAY—What is Treasury’s view of current and prospective skill shortages in the economy? Are there any areas there that are of concern? Dr Parkinson—Let me go back to the point I was alluding to earlier. If you have a sufficiently flexible labour market with incentives for people to accumulate skills and people are rewarded, and if you have an education sector and a skill development sector that is going to respond to people’s demands, then you have even less concern. Senator MACKAY—That is not my question. Dr Parkinson—I know that is not your question, but— Senator MACKAY—I am asking, quite specifically: are there any areas of current and prospective skill shortages in the economy which are causing Treasury concern? Dr Parkinson—And the answer to that question is no. Senator MACKAY—Thank you. MYEFO states that the global recovery continues to be overly reliant on US growth. Could somebody elaborate on that observation? Dr Kennedy—When we were forming our view at MYEFO, it certainly was the case that in the global economy it was mainly the US that was growing strongly. We had seen some recovery in East Asia broadly, but they were still coming out of the effects of the SARS epidemic. It is still the case that the global recovery is someone reliant on the US, because growth in Europe remains sluggish and continues to be sluggish. Growth in Japan has been surprising on the upside. In fact, we saw a release yesterday which indicated that growth in the fourth quarter in Japan was surprisingly strong, and I think that would have surprised most people. So there is some evidence that the global recovery, since we put MYEFO together, is broadening somewhat, and that gives us some more confidence, but it is still the case that growth in some areas is still quite sluggish. Also, areas other than Japan and East Asia are continuing to grow strongly. China, again, is growing very strongly, by over nine per cent in the fourth quarter. There is a sense that the global recovery is broadening, but still there is that reliance on the US to lead to some extent. Senator MACKAY—Do you see the strengthening in Japan as real? You said the growth was surprising. Dr Kennedy—The number was, I think, 1.7 on a quarterly basis, which is probably the highest quarterly growth rate we have seen in Japan for some time. In six out of the seven last

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 115 quarters in Japan we have seen growth. There are certainly signs that exports have been increasing quite strongly and, again, that is reflected in China’s growth and US growth. Related to that, investment has been growing quite strongly. Certainly there is strength in the Japanese economy. It is difficult to judge just how strong it is because there are issues that arise with the data. For example, there were revisions to the Japanese data in December which would have taken growth down by about half a percentage point. With the latest release all those revisions went back the other way, so we saw over half a percentage point added back on. That is a lot of activity for a country that is one of Australia’s major trading partners, so that makes it difficult to judge the strength, but there are certainly signs of recovery in strength. Senator MACKAY—Do you have anything more to add on that? Dr Smith—When we look to the medium term in Japan we would still have concerns about its potential growth. As Dr Kennedy said, a lot of the growth at the moment is generated by Chinese growth, particularly on the export and investment side, but there are some severe structural issues that need to be worked through in that economy. Within the financial system there is continuing to be reasonable progress on corporate debt workout, but Japan faces a number of structural bottlenecks, particularly in fiscal policy and on the demographic side. So, even though global growth is becoming more balanced, there is still that medium-term issue around Japan, which we would continue to have concerns about. Senator MACKAY—Thank you for that. I have a final question on MYEFO international risk. I refer to page 10, where it says: … a reduction in the US CAD may be associated with a period of lower US growth and a large depreciation of the US dollar. A disorderly adjustment involving a sudden withdrawal of funds from the US and a sharp depreciation of the US dollar would have significant negative consequences for the world economy. Could you comment on the situation now? Also, could you elaborate on this risk and indicate what you mean by ‘significant negative consequences’ in this context? Dr Kennedy—One could categorise that risk as having a low probability but which would have a very bad effect. I think that is also the way the IMF would see that response. It would be a risk that was built around people changing their view of how dynamic the US economy was and withdrawing their funds and choosing not to invest or fund the current account deficit. We note it as a risk but, as I said, it is a risk probably with a low probability. But, if something like that were to unfold, very large swings in currencies clearly impose costs on countries and would affect business sentiment—investment in particular—and we would potentially see consequences for global growth. Senator MACKAY—Is that the severe negative that you were talking about? Dr Kennedy—Yes. Senator MACKAY—I have some questions on employee entitlements. That is it for this group. ACTING CHAIR (Senator Chapman)—We will now move on to output 2: government spending and tax arrangements.

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[5.45 p.m.] Senator Coonan—Could we just have a discussion about who is still needed? There is a little bit of confusion about who is needed in fiscal, for instance. Senator MACKAY—I am not surprised. ACTING CHAIR—Output 2 is the only one left. Senator Coonan—Perhaps Senator Mackay can indicate who she wants so that we do not discharge anyone who is needed. Senator MACKAY—That is a really good idea, Minister. Thanks. We need fiscal strategy. I am not familiar with this committee, to be honest. We have questions on fiscal strategy, Treasury and the employee entitlements policy. We have some questions on the baby bonus. Senator Coonan—That is Tax. Senator MACKAY—That is right. Mr Murray—The reason we have asked whether it is output 2.1 or 2.2 is that in the Treasury, Senator Mackay, Fiscal Group covers 2.1 and Revenue Group and the tax office cover output 2.2. Senator MACKAY—Right. This is specifically 2.1, so that is you. I have some questions about a speech that was given by the Secretary to the Treasury recently. He is not here. Does he normally come to estimates? I have here Dr Henry’s speech to the Australian Conference of Economists business symposium in October. He said on page 13 of the speech: Thanks to the introduction of accrual accounting in the 1999-2000 Budget, we now have a general government balance sheet. The Government took the opportunity afforded by the accrual framework to add a supplementary fiscal objective of improving the Commonwealth’s net worth position over the medium to longer term. In the 2000-01 budget, one objective of the government’s fiscal strategy was improving net assets over the medium to longer term. In 2001-02 this objective was changed to improving net worth. In 2002-03 this objective was changed back to improving net assets. In 2003-04 this objective was again changed to improving net worth. What is going on here? Mr Murray—I recall the last change. I do not recall the previous changes. However, there is nothing going on here. As you probably know, under the Charter of Budget Honesty the government is required to report under international and Australian accounting standards, and that is what we do. The main standard is the government financial system standard, which is basically an IMF statistical standard, and the umpire, if you like, of how that standard applies to Australia is the Australian Bureau of Statistics. Under that standard, the bottom line in the balance sheet—that is, assets minus liabilities—is ‘net worth’. Under Australian accounting standards, which we also report under, that similar bottom line is called ‘net assets’. Even though there is some difference in the balance sheets because the standards are not exactly the same, the concept itself is the same. Because our main reporting is under the GFS, the IMF regime, it is better that we have as the target, or as the objective, net worth rather than net assets.

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Senator MACKAY—Why the move from ‘net assets’ to ‘net worth’? Are the main accounting standards changing? Mr Murray—No, not at all. As I say, I do not recall that we have changed back and forward. I thought we had changed from net assets to net worth in the last budget because we just wanted to have the right terminology. Senator MACKAY—Do you have a view on which standards are better? Mr Murray—It all depends on what you want to use the standards for. In essence, there is not a great deal of difference between the two standards, but they are trying to do slightly different things. The IMF standards are trying to say: ‘What is the effect of government activity, and the government budget in particular, on the macro economy?’ It tries to get at a bottom line that is the old sort of borrowing requirement concept, if you like, in the old cash accounting days: what effect, through government activity, is it having on the economy through its effect on borrowings or savings on the financial sector and directly on the economy? The accounting standards are really trying to do a slightly different thing. They are trying to measure what is the financial performance of the government, if you like. Those accounting standards are much more relevant to each entity within the government. So you will find when you look at the annual reports of all the agencies that they actually do not report under the GFS standard, that they report just under the accounting standard, because, like a business, you are trying to get at their economic and financial performance. They are the two standards. They are trying to do two different things. They are both very robust, and we report under both of them. Senator MACKAY—Thank you for that. On more substantive matters—not that that was not substantive—Dr Henry says in this speech: ... it would be fair to say that the part of the balance sheet that presently features in public commentary on the fiscal strategy is limited to net debt. It is conceivable that, at some stage in the future, the fiscal strategy might concern itself with a larger part—perhaps even all—of the general government balance sheet. Does Treasury have a view on whether there is any economic basis to this focus on net debt? Mr Murray—There certainly is. I will just give a little bit of history. Until recently, when the UK, the Australian and New Zealand governments all moved to accruals, most governments around the world were basically in a cash world and net debt was certainly a very large focus because it looked directly at the effects of government borrowing and then through to the stock of net debt on the economy. There was certainly fairly robust modelling done, particularly by the Bank of England, on the correlations between net debt and interest rates—that is, government net debt. So it was certainly quite a strong conceptual economic basis for looking at net debt. The other basis for net debt—and this is continuing even though we have an accruals world—is that it is fairly robust in terms of its numbering. We have a strong history of the net debt aggregate and the parts of the balance sheet are very robust in relation to those net debt figures, whereas the net worth—you could have a debate from here to kingdom come about what actually should be in the balance sheet, because you can have a fairly narrow balance sheet or you can have something that is much bigger that would take into account a whole lot

ECONOMICS E 118 Senate—Legislation Thursday, 19 February 2004 of assets and liabilities that at the end of the day may be very difficult to measure, but they are still assets and liabilities of the government. Hopefully, over time the balance sheet will become fairly robust as a concept around the world, and the net worth concept will become fairly generally used by governments all around the world, but to date that is not the case. Senator MACKAY—So is net debt an appropriate measure of fiscal sustainability? Mr Murray—Yes. If I go back to the issues about connections between net debt financial aggregates and the economy, certainly as countries move to higher levels of net debt there is no issue about the detriment that that can have. So my answer is yes. Senator MACKAY—Is net worth more important than net debt? Mr Murray—I think it is giving probably a wider picture but, as I say, as yet it is probably not giving as reliable a picture as net debt. Senator MACKAY—Going back to this previous point, if I can get this right: is Treasury arguing that net debt is a measure of fiscal sustainability at levels such as Australia’s? Mr Murray—Certainly Australia is in a very powerful position when it comes to net debt. We would take the view that maintaining those low levels of net debt is a worthwhile objective. Senator MACKAY—So is that a yes? Mr Murray—Yes. Senator MACKAY—Is Australia’s net debt too low, do you think? Mr Murray—It is certainly not too high! You could have a debate from here to Christmas on the level of net debt. Senator Coonan—Please, only till 6.30! Mr Murray—It is a very powerful position to be in, in terms of international financial markets. Senator MACKAY—Does that mean it could be increased without much risk? Mr Murray—That is a question that I probably could not answer. We have had a very large demonstration effect that bringing it down to its current levels—along with the whole fiscal strategy—has driven real interest rate differentials between Australia and the US down to round about zero. That has been a very powerful driver of the economy over the last six or seven years. Whether, if you were to move back up again, the credibility of fiscal strategy would be damaged, I am not quite sure. If it were damaged, I would have thought that would have a detrimental effect in terms of the interest rate differential. Senator MACKAY—On the basis of a damaging of credibility rather than anything more tangible? Mr Murray—Yes. Senator MACKAY—I understand what you are getting at. Mr Murray—And that is very important.

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Senator MACKAY—Yes. So you are saying that any increase in net debt could affect fiscal credibility? Mr Murray—It could. Senator MACKAY—The government tells us a lot about the merits of lower net debt, even when it has been predominantly off the back of selling assets. For the record, I am advised that Australia’s level of government net debt is around three per cent of GDP. Mr Murray—That is correct. Senator MACKAY—Do you know what the level of debt to GDP is in the US? I am advised that you have been through all of this before in previous estimates, but maybe you have not. Mr Murray—I do have a table here that my colleague Mr Martine has given me. According to this table, it is 47 per cent. Senator MACKAY—I had 45 per cent. What is the average across the OECD? Mr Murray—It is 48.7 per cent. Senator MACKAY—What about in the UK? Mr Murray—In the UK it is 29.4 per cent. Senator MACKAY—Does the investment community shun the UK because it has a public debt to GDP ratio of 30-odd per cent? Mr Murray—No, but, again, you have to put all of this in the context of where the UK economy has been, and indeed where the US economy has been, and what sort of productive base and fiscal credibility it has. You have to put all of those factors together and take them all into account to see where the financial markets are making their judgments. They have made their judgments about Australia in the past given our track record on policy and fiscal credibility. We have built up very significant credibility now. That is how you have to view issues about net debt and fiscal strategy more widely. Senator MACKAY—So what you are saying is that it is an inexact science and a lot about perception? Mr Murray—Yes, it is. The financial market participants will take a view on one country with one set of parameters and an entirely different view of another country with similar parameters. Senator MACKAY—But, clearly, there is nothing empirical about it given that, for example, we do not see higher interest rates as a result of a public debt to GDP ratio in the UK of 30-odd per cent. Mr Murray—No, but, again, you have to take that in the context of the Bank of England research clearly showing, not only for the UK but also for other countries as well, that higher levels of net debt do impact on the overall structure of interest rates, to the detriment— Senator MACKAY—And these are studies undertaken by the Bank of England? Mr Murray—Yes.

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Senator MACKAY—Has Treasury examined the IMF research that suggests, or so I am advised, that you need to get to about 40 per cent before it emerges as an issue? Mr Murray—Sorry, I do not understand what gets to 40 per cent. Senator MACKAY—I am advised that the IMF has undertaken research which shows that you need to get to about 40 per cent of— Mr Murray—This is net debt getting to 40 per cent? Senator MACKAY—Yes—before it emerges as an empirical issue. Mr Murray—I am not aware of that research. I do not know if Dr Gruen is. Dr Gruen—I am not aware of the exact IMF work that you are quoting, but work not only at the Bank of England but also at the Federal Reserve shows quite strong links between levels of government debt and long-term interest rates. That is not just above 40 per cent; that is over the range of countries. These studies are usually cross-country studies which use the experience of OECD countries, where there is quite a wide range of net debt, including Australia at three per cent and lots of countries like Japan at very high levels. As I said, I have not read that IMF study, but it is possible that they may have been getting at a related issue, which is that, if you have a high enough level of government debt, you raise the chance of a very severe loss of confidence, which we have seen in developing countries. Certainly, developing countries seem to be unable to sustain the sorts of levels of net debt that developed countries can sustain; but, as you raise the level of net debt, the possibility that there will potentially be financial crises goes up. It may be that what that study is talking about is that that probability remains negligible until you get to high levels of net debt. Senator MACKAY—With respect to the studies that you are citing, does that research suggest any problems at below, say, 10 per cent? Dr Gruen—What many of these cross-country studies try and do is put in the level of net debt and see whether they can get a statistically significant effect on interest rates. You are asking whether you can pick up a kink. In other words, are these cross-country studies sufficiently sensitive to be able to tell whether the relationship changes between above 10 per cent and below 10 per cent? Usually, with those things, it is very hard to be confident that you can actually pick that up. Senator MACKAY—As I understand, and you might want to take this on notice, the IMF research—and I am happy to provide the details on it to you—is a summary of developed country evidence. Maybe I could provide you with that and we could deal with that in the next estimates or I can put some questions on notice. Would that be an appropriate way to proceed? Mr Murray—Yes, certainly. Senator MACKAY—I will go back to Dr Henry’s speech. He says: Another intergenerational equity issue concerns the funding of economic and social infrastructure. Put simply, since public infrastructure assets, by definition, produce a flow of future services, there is a question of who should pay for them: present taxpayers financing capital spending or future taxpayers repaying public debt? Without getting into the debate, because that is not my purpose today, I would note that our present fiscal strategy supplies one answer to that question; the United Kingdom’s ‘golden rule’ provides another.

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As Dr Henry points out, the UK has two: the golden rule, balancing the budget over the cycle; and the sustainable investment rule, maintaining public debt to GDP at a prudent level, considered to be 30 per cent. He notes two contrasting approaches to funding public infrastructure, which I would like to explore in more detail, if that is all right. From a Treasury perspective, which of the two approaches referred to by Dr Henry makes more economic sense: the UK approach or the Australian approach? Mr Murray—You could have a debate about this from here to Christmas, Senator. The UK approach, if you take note there, is about not only balancing the operating balance over the cycle and that way allowing investment to be carried out through borrowings—that is, running deficits on what would be our fiscal balance—but also having the net debt target as well, so you are not just borrowing willy-nilly and having the whole debt situation getting out of hand. That is the first point. So they do have a net debt target and, in many ways, in looking upon that, a net debt anchor, if you like. The second— Senator MACKAY—But their target is keeping debt below 30 per cent. Mr Murray—Again, it gets back to my point that you have to take the context of a particular country in terms of financial market credibility. The second point is that, under the UK approach, you have to rely very much on what the economic and social returns from the investment are. That is a very difficult judgment, but, if the judgment is not made right, it can put your whole fiscal strategy very much at risk, because you are not actually in the long run delivering the benefits from that capital spending to future generations. Our approach is much more straightforward. It is an approach basically about what the overall effect of the government’s activity on the economy is. It does take into account the fact that the government is spending on capital and, if it was not balancing on that budget measure over the cycle, it would be going into debt and into deficit to fund these investments. So it is a much more straightforward approach to fiscal strategy and probably a much more cautious approach to fiscal strategy. Senator MACKAY—It is more straightforward, but is it as comprehensive? Mr Murray—I think it is as comprehensive, because you can still make quite clear decisions about your investments in infrastructure. Those decisions can still be taken. It is just that you believe, because of your fiscal situation, that you want to do that not through borrowing and not through going into deficit; you want to do that by paying for it as you go. As I say, it is a more cautious approach to fiscal strategy, and it does not run the risks that you do with the fiscal strategy in the UK where you are very reliant on those investments being made by the public sector returning the benefits in the long run. Senator MACKAY—But isn’t that judgment necessary in all investments? Mr Murray—It is, but if you look at Australia’s history—and you have to bear in mind here that a lot of these judgments in Australia are not actually made by the federal government; they are made by state governments—you will see that in the past a lot of those judgments have been very poor, and they have not brought the returns that governments have thought they would. I think it is important to recognise, too, that most investment in Australia is done at the state level, not at the Commonwealth level. A lot of those judgments are not directly and quite often are not even indirectly in the hands of the federal government. It

ECONOMICS E 122 Senate—Legislation Thursday, 19 February 2004 could be that the UK approach may be more applicable to state governments than to the federal government. Senator MACKAY—It is hard to disaggregate, though, isn’t it? Mr Murray—It is, but you have to recognise that, whenever we make a contribution to a lot of these investments, firstly, we do not have ultimate control of them because they are going out to the states; and, secondly, they never appear on our balance sheet. We will never know the long-run return on those investments, and those long-run returns will not directly come back to the Commonwealth, because we pass the funds to the states and it is on their balance sheet, not on ours. Senator MACKAY—Do you think our framework is too restrictive—you said that it is more straightforward and more cautious—in excluding investments that produce positive results? Mr Murray—No, I do not think it is restrictive. I think you have to recognise where this fiscal strategy has come from. It is come against the background of a significant blow-out in deficits in the early nineties and a significant increase in net debt. This fiscal strategy is a strategy built in that context. In that sense, it is a very appropriate strategy. Senator MACKAY—Given Australia’s very low level of public debt—I think empirically we can probably agree on that—is there any economic case for further reducing public debt while we attempt to finance particularly social, economic and environmental infrastructure? Mr Murray—You will find in the budget papers that, now we are down below five per cent, the government only talks about maintaining low levels of net debt, and I think that is appropriate. We are below five per cent, and it is a very comfortable position to be in. CHAIR—Mr Murray—perhaps you have already answered this; forgive me if you have— in this calculation of net debt as a proportion of GDP, is that Commonwealth debt, or does that include the debts of the state and territory and municipal governments? Mr Murray—No. Our net debt measure is the Commonwealth net debt. In the past we have raised some debt on behalf of the states and territories, but we no longer do that, and that part of our debt is fairly small. Senator MACKAY—Sorry to interrupt you, but just before we get onto that: is the comfortableness a change, or is that an example of a changed policy parameter? Mr Murray—No. Before we had the net asset, net worth objective, the objective on fiscal strategy was to halve the level of net debt. We achieved that some time ago. That was to get it from 19 per cent in 1995-96. We got down to that level in 1999-2000, so that target is no longer applicable. Senator MACKAY—So essentially you are saying here that net debt at the current level is comfortable? Mr Murray—Yes. Senator MACKAY—But the Treasurer actually talked about eliminating it entirely. Mr Murray—Yes.

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Senator MACKAY—Is there an inconsistency between these two statements? Mr Murray—No, I do not think there is at all. Senator MACKAY—I understand that the issue of public debt was discussed at length in the context of the bonds market review. Mr Murray—Yes. Senator MACKAY—The Treasurer made his view clear that we should have zero public debt. I will not ask you to comment on that. I assume Treasury does keep itself apprised of the public debt debate. Would it be fair to say that the dominant view of Australia’s economists across the political spectrum is that Australia’s level of public debt is very low, given our investment needs? Mr Murray—I have no idea. Senator MACKAY—Is Treasury aware of a single public finance expert in Australia that believes Australia should seek to further reduce public debt? Mr Murray—Again, I have no idea. Senator MACKAY—Is anybody else aware of anyone? Mr Murray—There is certainly a very wide range of opinion amongst economists about whether we should have the current strategy or whether we should have a golden rule strategy—and that does not surprise me in the least. Senator MACKAY—Is Treasury aware of any public debt finance expert that believes we should reduce our public debt further? Presumably Treasury does keep itself abreast of this sort of thing. Mr Murray—I think it would be true to say that all respectable economists agree that, in terms of what the government is saying, maintaining low levels of net debt is a good position to be in and a good position to stay in. Senator MACKAY—That is maintaining, not reducing. Are you aware of anybody who has talked about reducing or eliminating public debt and saying, ‘This is a good thing’? Mr Murray—I am not aware but that does not mean people are not saying it. Senator MACKAY—Do you think that— CHAIR—They are saying it, Mr Murray. I am not an economist, but I have read articles advocating each point of view—to leave the level of debt about where it is or to eliminate it entirely—and that has then gone to the question we have debated in this committee before about whether or not it is desirable to eliminate the bond market. So there are respectable advocates for each point of view. Mr Murray—Eliminating the bond market does not necessarily mean you are going to have zero net debt. CHAIR—I understand that. But that raises the issue as one possible way of eliminating that debt, doesn’t it?

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Senator MACKAY—I think the government has made a statement on the bond market, hasn’t it? It is very clear on that. CHAIR—Ladies and gentlemen, what we thought we might do is let you know that no officers will be required any longer other than those from the ATO. So all Treasury officers concerned in outcome 2 are excused. Senator Mackay has quite a lot of questions for the ATO, as do Senator Murphy and Senator Lundy. Notwithstanding that, we will definitely finish with the ATO by the end of this evening. Senator MACKAY—I need everybody under outcome 2. Senator Coonan—Do you want revenue? CHAIR—You do want outcome 2? Senator MACKAY—I think so. I need everybody. CHAIR—I am sorry. The position has changed, then. Senator MACKAY—Sorry. I think it was Kate and Shayne that had only ATO questions. I have questions that cover the gamut. I have specific ones on baby bonus. Senator Coonan—That is tax. Senator MACKAY—And Treasury. CHAIR—Okay, but we will still finish tonight. Senator Mackay will indicate through the secretariat shortly which Treasury areas she will be dealing with. Proceedings suspended from 6.22 p.m. to 7.34 p.m. ACTING CHAIR—The committee will resume. I call Senator Mackay in relation to outcome 2. Senator MACKAY—I want to start by asking some general questions on the work and family task force. Who represented Treasury on the work and family task force? Mr Tune—I was probably the key representative on the work and family task force, but Mr Murray and other people in Treasury also attended meetings. Senator MACKAY—What, broadly, were Treasury’s role and areas of responsibility on the task force? Mr Tune—It was just the same as any other department. Our role was to work through the issues that had been given to us and provide advice to the government. Treasury, as you know, is responsible for tax policy, and therefore there were some tax issues that were looked at as well. Senator MACKAY—Was there anything beyond tax issues? Mr Tune—The whole gamut of assistance for families is an issue that Treasury have a lot of interest in, and therefore we had an involvement in that. Senator MACKAY—Is it possible to be a little more specific than that? Mr Tune—The government has, as you know, family tax benefit parts A and B. Treasury has joint policy responsibility with the Department of Family and Community Services on

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 125 that issue. Part of the FTB is administered by the ATO, so there is a direct policy role for Treasury in that particular area. Senator MACKAY—Given that the interim report from the work and family task force recommended that the baby bonus be abolished and rolled into some form of paid maternity leave, has the task force commissioned Treasury to do any work on grandfathering the baby bonus? Mr Tune—I am sorry, but I cannot comment on anything that may or may not be in that report. It is a matter of government policy. Senator MACKAY—Let me ask a separate question, then. Has Treasury commenced any work on grandfathering the baby bonus? Mr Tune—I am sorry, but that is an issue around policy that I do not think I can answer. Senator MACKAY—Can you answer that, Minister? Senator Coonan—I am not in a position to make any comment as to the content of the report or the instructions that might have gone into it from the ministerial end. It does have a lot of cross-portfolio issues, so I am not really in a position to help the committee on that point. Senator MACKAY—How many meetings did Treasury representatives attend? Mr Tune—I suspect we attended all the meetings. I have a list of the dates here. I think there were 10 meetings. Senator MACKAY—What level of involvement did Treasury have, specifically, in costing the proposals in the task force report? Mr Tune—It depended on the sorts of proposals that were being looked at. Treasury would have been involved in costing tax related proposals. Senator MACKAY—Did Treasury undertake research that was specific to Treasury in terms of its input to the task force? Mr Tune—Yes, we did do some research. Senator MACKAY—What was that in relation to? Mr Tune—We did some research into the balance of assistance between single-income and dual-income families. That research is not published, by the way. Senator MACKAY—No, I appreciate that. That would have been commissioned as part of the task force work? Mr Tune—It was put into the work of the task force, yes. We thought it was an important issue to investigate. It was baseline data, more or less, to see where the situation lay. Senator MACKAY—Did you attend on Treasury’s behalf, Mr Tune? Mr Tune—Yes. Senator MACKAY—All 10 meetings? Mr Tune—I could not guarantee I went to all 10 meetings, but I went to virtually all of them, I think.

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Senator MACKAY—Mr Murray, did you attend any of them? Mr Murray—I attended at least half of them. Senator MACKAY—Would I be right in saying that most baby bonus assistance goes to middle-income families where one parent is not in the labour force? Mr Tune—I might have to draw on my Tax colleagues to assist on that one. Senator MACKAY—There is a bit of a crossover here. Mr Tune—The issue crosses both the social policy and the tax policy areas of Treasury. I could not tell you anything on the specifics of the baby bonus. The Tax people are here, so they can tell you. Senator MACKAY—All right. Senator MURPHY—The Treasurer announced an inquiry or a review—I am not quite sure what it was—into various tax matters in November last year. Mr Tune—Mr Smith is probably better qualified than I am to comment on this. Senator MURPHY—Could you tell me where that is at? ACTING CHAIR—Could you be more specific? Senator MURPHY—I think Mr Smith knows what I am talking about. Mr Smith—You are referring, I presume, to the review of self-assessment? Senator MURPHY—Yes. Mr Smith—The review of self-assessment is expected to release a discussion paper. That is its first task. We expect to see that released within about a month. Senator MURPHY—What is its process or progress after that? Mr Smith—The plan is to release the discussion paper and then to consult on the discussion paper for a time. Then, subsequent to that, the government will obtain advice from us as to any options that might have emerged from that process. Senator MURPHY—Will the discussion paper determine or further determine the terms of reference for the inquiry? Mr Smith—No. The terms of reference were released with the November statement. Senator MURPHY—If the terms of reference are already fixed, I am curious as to why you would have a discussion paper. Mr Smith—Discussion papers are pretty common, really, in inquiry processes. Senator MURPHY—They might be common but they are not necessarily always useful. Mr Smith—I will let you make any comments you like, Senator. Senator MURPHY—I read the terms of reference for the inquiry, and I am curious as to why you are not getting on with it. Mr Smith—As I say, the discussion paper will be released, and perhaps when you see it you could let me know how useless it is.

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Senator MURPHY—It might be like some of the discussion papers that have been released by the Inspector-General of Taxation. Senator Coonan—That is not what you said last night. Senator MURPHY—I made no comment in respect of their usefulness or otherwise. I did raise a question about the usefulness in the sense of what it all means—we may have an inquiry or we may not. For the purposes of the taxpayers of this country, I would have thought, given the Treasurer’s announcement, you might have just got on with the job and done what needed to be done. I would have thought there was sufficient evidence at hand to suggest that you do not need a further discussion paper to identify what you might need to look into. Senator Coonan—The point perhaps was that it was a policy decision to do that and not Mr Smith’s say-so. Senator MURPHY—I appreciate that, Minister. In response to a question I asked on 6 November, which related to the annual report at that time and was about the amount of money—$50 million—that is said to have been paid by taxpayers who have settled with regard to the mass market of tax investments, I received an answer that taxpayers who have settled their mass market investment scheme involvement currently have an outstanding income tax debt of $365 million. Has the position improved much since then? Mr Fitzpatrick—That was a fairly recent answer, so I am not sure whether there are any updated figures. I do not have any updated figures tonight. Senator MURPHY—Can you tell me exactly when this figure was arrived at? Mr Fitzpatrick—It was arrived at the time when we answered the question. It was fairly recent. Senator MURPHY—Yes, I know you have answered the question recently. Mr Fitzpatrick—At the time of receiving the question, we looked at the position in regard to cases which had settled and calculated how much was outstanding in relation to those settled cases. Subsequent to that there have been some further cases, as I understand—— although not many, in recent months—which have been settled, so the figure will change. As you know, there are people who settled on the basis of a two-year interest-free period payment arrangement, and those payment arrangements would have been entered into with those taxpayers. I assume taxpayers are paying off amounts in accordance with the arrangement entered into, so we would expect the figure to go down over time as people pay off their settled amount of debt. Senator MURPHY—Are you able to identify the number of people that took the settlement on the basis of the two-year interest-free period and over what time? Do you have any idea of how long it might take to get the $365 million back? Mr Fitzpatrick—No. The taxpayers were offered the two-year interest-free period, and I imagine many of them would have taken that offer rather than pay off the amount immediately. Some might have paid off immediately, but I do not know what percentage.

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Senator MURPHY—Are you able to identify the number that took the two-year interest- free option? Mr Fitzpatrick—I think the great majority took the two-year interest-free option as part of the settlement offer. Senator MURPHY—Are you able to identify the percentage of them who did? Mr Fitzpatrick—I cannot give you an answer tonight. We would need to look at that and see what we can provide to you on notice. My expectation is that the great majority would have taken the two-year interest-free period. Senator MURPHY—I am wondering what portion of this might ultimately become bad debt. Mr Fitzpatrick—I would hope a very small proportion. Senator MURPHY—So would I. Mr Fitzpatrick—I cannot answer that for you. Senator MURPHY—That relates to people who have taken the settlement offer. What is the amount of debt outstanding for people who have not taken settlement? Mr Fitzpatrick—I do not have an answer to that. Senator MURPHY—Can you take that on notice and also indicate to me the figures in respect of EBAs, in the same form. I assume the debt you are talking about here relates to mass market investment schemes. Mr Fitzpatrick—That is correct. Senator MURPHY—Other than EBAs? Mr Fitzpatrick—That is correct, as I understand. Senator MURPHY—Could you give me those figures for EBAs as well? Mr Fitzpatrick—The EBAs, as you would be aware, are a different situation in relation to cases settled. They did not get a settlement offer based on a two-year interest-free period or anything like that. Many of the EBA cases have been resolved, and I imagine they would have been paid as well—so it is a different position altogether. Senator MURPHY—Yes, I understand that. I would like to get the figures, though, on what the outstanding debt level is. I would be interested in getting some idea of how the tax office intends to recover this debt over time and what plans you have to address that particular matter. Mr Fitzpatrick—In relation to EBAs? Senator MURPHY—And also the $365 million and whatever the amount is that is outstanding from those that have not settled. Obviously the courts have a role to play. Mr Carmody—I suspect the vast bulk of the $365 million, as Mr Fitzpatrick has indicated, is under payment arrangements. The offer was for two years interest-free, and I imagine most people would decide that is worth taking, rather than paying up front. For the matters in dispute, as we work through court cases we will get to a point where, on those particular

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 129 cases, we will decide to take action on the debt in accordance with our normal standards. I also suspect we will get to a point where we find that the overwhelming position of the courts is that it will be time to move on all of them. Senator MURPHY—I wish you well. Thank you. Senator MACKAY—Before we go to Tax, did Treasury do any work on effective marginal tax rates by single- and dual-income families to advise the committee? Mr Tune—We probably would have. I am trying to think back, but I suspect we would have. Senator MACKAY—Did Treasury do any work on allowing individuals to opt out of the self-assessment system? Mr Tune—No, I do not think so. Senator MACKAY—I will come back to that one. I would not mind opting out myself. Let us go to Tax then. There are a number of outstanding questions on the baby bonus that ATO has not provided answers to the committee on. Can you please advise why they have not been provided? I understand they were put on notice in November 2003. Mr Carmody—Yes, they were. Unfortunately, they have not been resolved, but we will be looking to provide those answers as soon as we possibly can. Senator MACKAY—What is the nature of the delay? This is fairly unusual, even from my experience. Mr Carmody—Those questions asked for a level of detailed analysis, and we said that we would examine whether that was possible. That has taken us some time. As part of normal process, our analysis been provided to the minister’s office, and there has been some discussion about whether the figures accurately reflect what was requested. We are trying to resolve that. Senator MACKAY—When were the answers provided to the minister’s office? Mr Carmody—I do not know precisely. Senator MACKAY—Does anybody know? This is a fairly standard question. Mr Carmody—What was the date by which they were required? Senator MACKAY—November. Mr Carmody—No; there was a submission date in mid to late January. We were advised that was the submission date. Senator MACKAY—That is right. I think it 60 days. Mr Carmody—The date which we were advised of when we were departing the last hearings was mid to late January, and I think we provided all but a couple of those by that date. Senator MACKAY—Okay; just so long as we know where the responsibility lies. As you say, there was the usual argy-bargy and toing-and-froing and presumably they are in the pipeline, to use a well-known phrase.

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Mr Carmody—Yes, that is a fair description. Senator MACKAY—Minister, do you have any idea when they will be provided to the committee? That is a fair delay, as you would probably accept. Senator Coonan—That is a fair comment, but some of the data is complex. I would expect an answer would be settled in the reasonably near future. I cannot give you an actual date, but I take on board what you say. Senator MACKAY—In the June 2003 budget estimates, Treasury did not provide, as I understand it, the 2004-05 and 2005-06 forward estimates for the baby bonus. Why were they not made available? Mr Gallagher—In the portfolio budget statements for the 2003-04 budget there was an amount listed as an estimated agency expense on the baby bonus for 2002-03 and 2003-04. Senator MACKAY—That is correct, yes. Mr Gallagher—The out years were not listed. My recollection is the unpublished information was taken as a question on notice, and the answer was probably along the lines that this data has not been published. Senator MACKAY—So what about those out years? Mr Smith—The portfolio budget statement provides for two years for everything, not just for this matter. That is the normal practice with the affairs statement. Senator MACKAY—What was the final cost for the baby bonus in 2002-03? Mr Gallagher—The 2002-03 cost, as listed in the portfolio budget statement, was $60 million. Senator MACKAY—Has that been revised at all since then? Mr Smith—There is no revision in the additional estimates. Senator MACKAY—It has not been revised? Mr Smith—There has been no publication of a revision. Senator MACKAY—I know there have not been any publications, but has there been any revision? Mr Smith—I think the revisions would have been provided in the additional estimates if there were any, but I know there are not any there. Senator MACKAY—So the answer is no? Mr Smith—I am not aware of any revisions. Senator MACKAY—So the forward estimates for 2004-05 and 2005-06 are in the ‘in the fullness of time, at the appropriate juncture and do not hold your breath’ category? They are on the way. Mr Gallagher—I would expect that in the portfolio budget statement for the coming budget the next financial year will be shown.

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Senator MACKAY—Would I be right in saying that most baby bonus assistance goes to middle-income families where one parent is not in the labour force? Mr Carmody—I do not think I can answer that. We would have to analyse that. Mr Gallagher—There is always an issue in identifying the partners of claimants. That cannot be done with certainty from tax returns, which are on an individual basis. You cannot be certain about the distribution of taxable income of couples, which is the question that you are asking. Certainly, the distribution of taxable income of claimants is at the lower end of the income distribution. Senator MACKAY—Can we expect the forward estimates to reflect the published reductions? If there are reductions which have not been published, will the forward estimates reflect those? Mr Smith—If there are revisions—and, as I said, I am not aware of any—in forward years, they would probably be parameter revisions, program-specific parameter revisions or something of that kind, if they were to flow through to a forward estimate variation. It would not be usual, necessarily, to publish those or separately identify them. Senator MACKAY—How could we see those, as a committee? Mr Smith—Changes to forward estimates of individual items that are not otherwise published? Senator MACKAY—Yes. Mr Smith—That is something you can request, but it is really at the discretion of ministers to release additional information. Senator MACKAY—Did Treasury, in its various incarnations, present any evidence to the task force about the asserted disadvantage of the baby bonus on women who return to work? Mr Tune—You are getting into issues of what was done in providing advice to the government, and I do not think I can answer that. Senator MACKAY—Did Treasury undertake any analysis of women eligible for the baby bonus compared to the number of women eligible for paid maternity leave? Is there any data on that? Mr Tune—I cannot recall any analysis, but I can take on notice to see if we did anything. If it relates to any advice we gave to the government, I would have to separate the two things. Senator MACKAY—Has any modelling been done with respect to the income levels of families receiving baby bonus payments and the labour force attachments of new mothers? Mr Tune—Not that I am aware of. I do not know if Mr Gallagher knows of something, but I do not. Mr Gallagher—When the original costing was done, we attempted to use cross-sectional data, looking at women whose children were under the age of one or nought to two and women of the same age without children to try to get a handle on what the change in income may be. I have previously gone through how we approached that original costing with Senator Sherry. When the costing was done, there was an attempt to do that, but of course we did not

ECONOMICS E 132 Senate—Legislation Thursday, 19 February 2004 have data on the claimants at that stage. We were just using cross-sectional income survey data to try to get a handle on the issue. Senator MACKAY—What happened once the information on the claimants became available? Mr Gallagher—Because the returns are being processed, we now know more. There is a capacity to produce more information on their incomes than there was before. Senator MACKAY—Has that work been done? Mr Gallagher—I think it has started to be done. I am not aware of anything that is a solid report, but the tax office would undertake some of the work, so they may be more aware than I. Mr Carmody—I cannot give you the detail. There has been an amount of detail requested in those earlier questions, and the answers are presently on the way. Senator MACKAY—You will need to take this question on notice, I suspect. Can you provide the number of baby bonus claims and the level of payments made to families earning less than $30,000, between $30,000 and $50,000, more than $50,000 and more than $80,000? I presume you would not have that at your fingertips. Mr Gallagher—You are asking a question on family income, rather than personal income, and I said that there will be issues in any tabulation on the basis of family income, given that we have an individual tax system. Senator MACKAY—Can you provide the number of baby bonus claims? Mr Carmody—We will take that on notice. Mr Smith—Is there a particular year you are after? Senator MACKAY—Since the inception of the program. You must have an idea. Mr Smith—We have answered that question once before that I am aware of. Senator MACKAY—What was the answer then? Mr Smith—154,000 as at 7 October 2003, I recall. That was for the 2001-02 year which was, of course, only a part claim year. Senator MACKAY—I understand that. Mr Smith—It is not much use. Senator MACKAY—What about year to date? Mr Smith—No, I do not have any numbers at all. Senator MACKAY—That 154,000 figure was of when? Mr Smith—It was as of 7 October 2003—but that was not in respect of claims to that time. That was in respect of the 2001-02 claim year only. I cannot be sure whether there were any claims in respect of the 2002-03 year. Senator MACKAY—There are no more up to date figures than that? Mr Smith—We would have to take that on notice, because we do not have those numbers.

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Senator MACKAY—Have there been any? I presume that there have. Mr Carmody—There would have been claims, certainly. Mr Smith—I am sure that there are numbers that exist but, as I say, we do not have them here, and w would have to take that on notice to see whether or not the government wishes to release further information. Senator MACKAY—What was the lowest payment made under the baby bonus? Mr Gallagher—Obviously, there would be some payments which are low. Some people will have had their claims rejected, so I imagine the answer is zero, ultimately. Senator MACKAY—I asked for that one! What was the lowest payment made? Mr Gallagher—I do not have that information. I will take it on notice. Mr Smith—Because it can occur on a part-year basis, you can have a very small claim. Mr Gallagher—The minimum payment which exists can be influenced by the time in the year when you had the baby. If you had the baby in the last week of the year, the payment could be quite small. Senator MACKAY—Can you take on notice to provide a breakdown of the number of claims made and the level of payments to women who have been in the work force full time, who have been in the work force part time and who have not been in the work force? Mr Gallagher—I think that will also be an issue of tax data, because tax data does not discriminate between people who are working full time and part time. Tax data merely gives you information on their wage and salary income and then, ultimately, their taxable income. You have to infer full-time or part-time status. Senator MACKAY—Ms Macklin’s office has provided an example, and I would like to run through it and get a response. A constituent has written to Ms Macklin. I will give you a precis of the issue. It is in respect of a person called Mary Doyle. Ms Doyle’s baby was due in mid July 2003, but the baby actually arrived two weeks early on 30 June. I am advised that, as it was six hours before the end of the financial year, she was entitled to zero dollars. Obviously, had the baby arrived a few hours later, she would have received the full amount as it would have been the beginning of the next financial year. Is it fair to say that Ms Doyle and a majority of families are missing out on the baby bonus because of when their babies are born in the financial year? Mr Carmody—I would not have thought so, because the scheme is over a five-year period from birth. They might not get a claim in a particular year because the baby was born in a subsequent year, but as a product of the fact that the baby was born they would be entitled to claim following that. Mr Gallagher—My understanding is there is some choice in the scheme about which year you claim as your base year. Senator MACKAY—We will get to that. Doesn’t this raise a question about the difficulty with providing the baby bonus when the baby is born, from a logistical perspective?

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Mr Smith—Presumably an entitlement which is in the subsequent year is paid at a later time than in the prior year. Senator MACKAY—I did not quite understand that. Mr Smith—I was not sure whether you were implying that the payment would be made at the same time, irrespective of the year. Senator MACKAY—The issue is the timing at which the baby bonus is actually paid. Mr Smith—Yes. Senator MACKAY—There is an issue surrounding that, I am advised. Mr Gallagher—It clearly has a different timing than something like maternity allowance, because it requires a taxation assessment. Therefore, it cannot be paid until the relevant taxation assessment has been made. There is a need to demonstrate the change in income, given the design of the scheme. Senator LUNDY—I have about half an hour’s worth of questions that relate to the corporate services area and the IT outsourcing. Senator MACKAY—We will come back to the baby bonus issue. Senator LUNDY—I see there is a new CIO at Tax. Is that right? Mr Carmody—Yes, there is. Senator LUNDY—Who is that? Mr Carmody—My colleague Mr Gibson. Senator LUNDY—He is here! Come to the table. I would like to refer to an article that was published last year in the Australian: ‘ATO’s new boss reviews systems’. The article refers to a review of ATO’s standard operating environment. I have found a document on the web site called ‘Current Technology Environment at the Australian Taxation Office’ dated June 2003. Is this a current document? Mr Farr—I also have some responsibilities in the IT area. That is probably the last document that describes what our standard operating environment was. However, as part of our change program we have been out to the industry to look at solutions to deliver a better customer experience. We have flagged to the industry that, given the level of change that we anticipate to our IT platform at this point in time, they should not restrict any solutions they wish to bring back to us to what has previously been our standard operating environment. When we have finalised the evaluation of those responses, I suspect we will have a quite different standard operating environment. Senator LUNDY—From that document? Mr Farr—Yes. Senator LUNDY—Because of changes that have occurred since then? Mr Farr—That is correct. Senator LUNDY—Can you tell me where I can find a copy of another document titled ‘Standard Operating Environment’, which is referred to in that article?

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Mr Farr—I do not have the article here. We need to be clear, when we are talking about a review of our standard operating environment, that it is not necessarily a review of the document. We have been very clear with the industry that the responses that they are giving us to the range of software products and solutions that we have been out for should not be constrained by that standard operating environment, as has previously been published. Senator LUNDY—The article makes reference to previous evidence collected by this committee, where the tax office made it clear that you ensured that you had a number of operating environments and that you did not become captured, or particularly bound, by one. The article makes it clear, in reference to this document, that in fact you almost exclusively develop on .NET. Mr Farr—That is not so. We primarily develop our front-end web type applications on .NET. The majority of our applications run in our mainframe, which is a combination of Cobol, Talon and COOL:Gen. Senator LUNDY—Are you conducting a review of your standard operating environment? Mr Farr—As I said, we have been very clear on the business outcomes that we are seeking to achieve, the community experience that we are seeking to achieve and the sustainability. In that review, we are not being constrained by our current operating environment. We are reviewing the IT support we need to achieve our business outcomes, without being constrained by our standard operating environment as it was. Senator LUNDY—Can you point me to the document that is referred to in that article, a document on the ATO’s standard operating environment? Are you aware of such a document? Mr Farr—There is a document that would set out our standard operating environment. My understanding is that it would be fairly common for that document to go out with any tender processes. When we had a settled operating environment, that would have been the case. In the last lot of procurement, as I said, we have said, ‘Don’t be constrained by that. Bring back your solutions without being constrained by that standard operating environment.’ Senator LUNDY—Does that mean that the ATO is prepared or willing to move away from its reliance on Microsoft software quite specifically? I think I am in a position to say that, because in the document that I referred to, the one that was on the web site, wherever there is mention of an operating system, it is pretty much exclusively Microsoft. There are a few other things there, but it is certainly nothing like the impression I was given at a previous Senate estimates about Tax having a balanced approach and maintaining a competitive tension across a number of different platforms. Mr Farr—There are probably a number of aspects to that question, Senator. The short answer is that we are not making any specific decision to stay with or move away from Microsoft. What we are doing is allowing the business requirements to dictate to us the type of product that would be most suitable for those needs. As a result of tender processes and requests for information that we have conducted, we are in the process of negotiating with a number of vendors. Although it is probably not prudent to discuss contracts that are still being negotiated, it is fair to say that we are likely to have a fairly broad mix of products as a result of that.

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Senator LUNDY—Is that the Change Program? Mr Farr—That is correct. Senator LUNDY—I have some questions on that shortly. What you are talking about is what you have described generally as the Change Program? Mr Farr—It is not unusual. Just about all well-run IT shops would keep to a minimum the amount of product diversification: it is costly, the integration is costly, the multiplicity of skills that you need to support it is costly. That is not an unusual strategy. Senator LUNDY—I put to you that, when you spend a significant amount as Tax does, maintaining some competitive tension within your organisation is probably a pretty good idea too. Mr Farr—All of those have to be balanced. There are costs either way, but there is a significant cost in running a multiplicity of different environments. That is not to say you have to stick to one, but you need to minimise. Senator LUNDY—How many do you have at the moment? A lot? Mr Farr—Most of our major applications run on a mainframe environment. We have a small number of applications—from memory, 11—running in the mid-range environment, which is primarily Microsoft. That mix will probably change as a result of the Change Program. Senator LUNDY—I want to challenge you on the mix that you say you have. Just looking at the document I got off the Web, it is pretty pro-Microsoft all the way through. There is no Linux mentioned. The references to UNIX are restricted. UNIX is a restricted system in the scheme of things. In June of last year Mr Wilson told me: There are two major competitors in the market place: J2EE and .NET. They are very viable alternatives. It is pretty important that we have a degree of competition in the marketplace to try to keep the various parties that offer these services honest, and I think they are valid alternatives. Yet according to the article I was referring to, the ATO now develops almost exclusively in .NET, and in the document I found, as I said, Java is hardly mentioned at all. Why is that and why do you keep maintaining that you have a balance when all the evidence points to the contrary—that is, contradicts evidence taken previously in this committee? Mr Farr—It is absolutely true that predominantly in our mid-range environment we use Microsoft products. As we move to greater emphasis on that, as we move to the Change Program and different ways of doing things, there will be a greater mix of products. As I said, it is probably not wise for me to go into outcomes of processes where there— Senator LUNDY—I put to you that, in one of the RFI or associated documents, there was reference to the fact that J2EE or Java is not recommended or supported. Have you ever put that statement in any of your requests for information or RFTs? Mr Farr—Quite possibly but not, as I understand it—and I would have to have a look at the document, Senator—in the Change Program, which is the major change to the IT platform. Senator LUNDY—What about previously?

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Mr Farr—Previously that could well have been the case. Senator LUNDY—Can you take on notice providing me the specific information about whenever you have made those suggestions, or any statements and the circumstances where you have recommended excluding any of the major competitors in the operating systems base? Mr Farr—Yes, we can do that. Senator LUNDY—And provide an explanation? Mr Farr—How long would you like us to go back, Senator? Senator LUNDY—The document I am referring to is June 2003, so perhaps to June 2003. Mr Farr—We can do that. Senator LUNDY—Hopefully, that will embrace all of the Change Program initiatives. Mr Farr—Yes, it should. Senator LUNDY—When did you start releasing RFIs for that? Mr Farr—For software products, July 2003 from my recollection. Senator LUNDY—I will take your word on that. Make it just for this current financial year. Mr Farr—We could possibly also give you some of the documentation we sent out with the Change Program that explains how we are opening it up. Senator LUNDY—Yes, and if the RFIs are publicly available, if there is no secrecy or anything around those, could you provide those to the committee as well? Mr Farr—I would check that, but I cannot imagine there would be any reason why they would be secret. Senator LUNDY—I would not see why, when anyone interested would be getting hold of them. Last June, Tax mentioned that you had commissioned some work to look at open source technology. What were the results of that exercise? Mr Farr—That is still continuing, Senator. We did an internal review and we have engaged Gartner Group to assist us in that review. They came back to us in early December with some key findings: we should actually develop open source software policy; we should review our existing processes to enable the evaluation and selection and sharing of open source software. As you can imagine, the evaluation of particular open source software is potentially different from proprietary software. Senator LUNDY—You can actually see the source code. Mr Farr—That is right. We should investigate opportunities through the open source model for innovation. What we have done is had the first draft of a policy which recognises that there is an increasing maturity of open source software and that we should be starting to fully analyse and make use of open source software where it is appropriate to do so. We have started on that process and we will be looking at it over the next 12 months. Gartner reported

ECONOMICS E 138 Senate—Legislation Thursday, 19 February 2004 to us that there is some increasing maturity in some of these products and pointed to some places where we could perhaps start looking at it. That will continue. Senator LUNDY—In terms of that Gartner report, is that able to be provided to the committee? Mr Farr—Once again, Senator, I do not see why not. Senator LUNDY—Thank you. Is the review of the standard operating environment including a specific consideration of open source? Mr Farr—Without getting too detailed about things that we would perhaps be getting to the market in, we certainly would not be ruling out the use of open source where it is appropriate to do so; so, yes, that is certainly on our mind. Senator LUNDY—I notice in the standard operating environment document that Microsoft software was almost exclusively chosen for email but it was not selected for secure email. Why was that? Mr Farr—I do not know the answer to that, Senator. I would have to take it on notice. Senator LUNDY—Does it imply that the Microsoft product is a security risk or has a lower security rating? Mr Farr—As I said, I do not know the reason why that was chosen, but I will take that on notice. Senator LUNDY—Are the reports that the ATO will be adopting the as yet incomplete Microsoft Longhorn operating system true? Mr Farr—We may adopt it eventually. There are no plans to and no evaluation of it at the moment. Senator LUNDY—Has the ATO committed in any way to this untested system? Mr Farr—No. In fact, I read that report in the paper and I— Mr Carmody—And I asked him, ‘What are you doing?’ Senator LUNDY—So you deny—deny, deny, deny. Mr Farr—We simply have not turned our mind to it. I asked the people who were in the room with me at the time, who were all members of the IT exec, what was going on and no- one had ever heard of an analysis of it. Senator LUNDY—The reports I have read regarding the Change Program say it will cost around $800 million. You look as if you really desperately want to comment on that figure, Mr Carmody. Would you like to make a comment on that? Mr Carmody—I read those reports with shock and had some discussions with my people and indicated that it did not sound very sensible to me. Senator LUNDY—You probably were aware of your existing IT budget and wondered where you were going to get another $800 million from. Do you have a ballpark figure for the Change Program? Can you isolate a cost associated with the Change Program as yet?

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Mr Farr—We have done some internal calculations. I am not sure how wise it is to make it public at the time we are in the marketplace. Senator LUNDY—A ballpark figure would be useful. Do you think you are in a position to even provide a ballpark figure? Mr Farr—Not other than to say nowhere near $800 million. Senator LUNDY—I will take that as meaning less than $800 million. Mr Farr—Less, yes. Senator LUNDY—Although we have had previous estimates where it could easily have been interpreted the other way. Can you tell me about the tender process for this project and what stage it is at? Mr Farr—We have been through a number of stages up until now. We first went out for a tender for people to assist us in putting together the project, the overall strategy for it. For that we went out to, I think in round terms, 20 different companies to give us proposals. Senator LUNDY—So it was like a selective tender process. Mr Farr—It was selective, but it was quite broad. It was not like two or three selective tenders; it was in the twenties. Senator LUNDY—But you invited 20 to respond? Mr Farr—Yes. A number of them did. Senator LUNDY—How many? Mr Farr—I cannot tell you that. I will have to take that on notice. Senator LUNDY—Maybe half of the 20? Six? Mr Farr—It was not an enormous number; it was probably half a dozen. Senator LUNDY—Around half a dozen? Mr Farr—Yes, that was my recollection of it. We then went out to an open tender for the selection of a program implementation partner, as we described it. That was in July 2003. We made it quite open to the industry. We offered industry briefings, seminars and documentation, including all the documentation we had accumulated during that first stage of the project. We made it open to the whole industry so that everyone was on the same playing field. We had 300 to 400 people representing about 150 companies who came to the discussions and, at the end, we got six tenderers for that. We reviewed each of those tenders and what we found ultimately was that none of those tenderers covered the full breadth of what we wanted. Some of them were very good in parts but none of them had the full breadth. Senator LUNDY—Is that why you cancelled it? Mr Farr—That is correct. What we have done now is moved on to the next phase of it, which is a quite restricted phase. We have engaged Accenture—the highest ranked in that particular aspect, which we want to do now—for a short period of work which is finalising either this week or next week.

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Senator LUNDY—I will come to that Accenture contract in a second, but first of all can you provide the committee with the tender documentation, or the CD or whatever, for the original tender? Mr Farr—The original tender being? Senator LUNDY—That was cancelled. Mr Farr—The one that was cancelled? Senator LUNDY—Yes. Mr Farr—Yes, I think so, Senator. Senator LUNDY—Just to go back over it, you had one where you invited 20 companies to respond and you got six. Mr Farr—Yes. Senator LUNDY—Then it was another process where you went more broadly? Mr Farr—That is right. Senator LUNDY—Just explain the relationship between those two processes. Mr Farr—In the first process what we wanted to do was get an idea of a business case, whether we were in the ballpark, and an overall strategy on how to move forward. When we got that and the thinking behind it, we made that available to the industry generally, to anyone who wanted it. We provided that and then went to an open tender, or an open request for information, for people who wished to respond. That is where we got the six respondents. Senator LUNDY—But it was then cancelled. ACTING CHAIR (Senator Watson)—Before you continue, there are a number of witnesses here that may not be wanted. Can you give us some indication of the people you might wish to remain. Senator MACKAY—I have briefs that cover a very broad area, so I think that is going to be quite difficult. ACTING CHAIR—On mass marketing? Senator Coonan—Perhaps I can be of some assistance to the committee. We had in mind particularly Kevin Fitzpatrick and the mass market schemes that Senator Murphy asked questions about. ACTING CHAIR—What about the superannuation guarantee? Senator MACKAY—Yes. Let us keep going. ACTING CHAIR—Mr Fitzpatrick, you are excused. Senator LUNDY—I only have about 10 minutes maximum to go so I will keep moving. There were two processes: there was the selective tender and then you considered that information and went to another open tender and had a different six responses to that. Mr Farr—There was some commonality, but additional, yes.

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Senator LUNDY—Are you able to tell the committee how much you think the companies that responded to that second process spent on that exercise that was subsequently affected with the cancellation of the tender? Mr Farr—I do not have any idea of that. It was specifically targeted, from my recollection, as a request for information, to keep the costs to the minimum. I would not be able to guess what individual companies spent on preparing. Senator LUNDY—I suspect at least a reasonable amount of money as part of that exercise. Can you explain—and you started to, so I will get you to go back now—your justification for selecting Accenture? I think you said they were a respondee to the original tender. Mr Farr—They were. For the aspect of the phase we moved into, the short phase, they were the highest ranked respondent. Senator LUNDY—What proportion of the business under the original tender was awarded to Accenture? What is the nature of that component they were awarded? Mr Farr—The proportion is very small. It is a very small portion. It is difficult to go into it without giving away how much we think the whole thing is ultimately going to cost. It is really around the overall high-level design of a firming up of the business case and a strategy for moving forward. It is, once again, at a fairly high level of the next phase of how we move forward in a program of this size and complexity. Senator LUNDY—That was awarded, effectively, either as a subset of or outside the original competitive tender exercise, or the requests for information exercise. Mr Farr—It was outside of that information but we relied on information that we had received during that process. Senator LUNDY—Given that the reported value of the program is $800 million and you have challenged that, I presume when you say ‘nowhere near that’ you would still be talking about a substantial amount. Mr Farr—For the program? Senator LUNDY—For the program. I want to try and get an idea of the proportion that Accenture was awarded because the way it looks at the moment is that you had all these companies go through this process, to lodge a tender at their expense, cancelled it, and then plucked Accenture out of the group to do, I presume, some high value-add work and to hell with the rest of them. Mr Farr—I do not agree with the last bit, obviously. To put it in perspective, without going into what we think the size of the total program might be, the work that we are having Accenture do at the moment is probably around $800,000 worth of work, so it is not a big chunk. Senator LUNDY—Does this satisfy probity requirements and do you have a probity auditor monitoring these processes? Mr Farr—Yes. We did a number of things to ensure that the probity of the processes that we were undertaking were of the highest order. We recruited a number of very experienced

ECONOMICS E 142 Senate—Legislation Thursday, 19 February 2004 procurement people from other agencies. We employed a legal adviser who was also very experienced in this. We had a probity adviser. Senator LUNDY—Who was that? Mr Farr—Walter Turnbull. I can remember his name, Senator. The probity adviser was Walter Turnbull, the probity auditor was Acumen Alliance and our legal advisers were Blake Dawson Waldron. Senator LUNDY—All familiar names in IT outsourcing. Mr Farr—We look for people with experience in that area. Senator LUNDY—Did Accenture’s relationship with Microsoft make them more attractive to the ATO? Mr Farr—I am not sure what Accenture’s relationship with Microsoft is. Senator LUNDY—Let me be specific. Will any of Accenture’s business with the ATO be subcontracted to Avanade, which is the Accenture Microsoft joint venture. Mr Farr—It has not been discussed in any way and I would not think so, Senator. Senator LUNDY—Do you have Avanade on your books for any work? Mr Farr—Not from my recollection. To give you a categorical answer to that, I would have to take it on notice, but I am not aware of any. Senator LUNDY—Will cancelling the tender cause a delay to the delivery of the changed program and are any other tenders going to be scrapped in this way? Mr Farr—Will it cause any delay? I guess the next week or so will show that, as we do the further analysis. Will any further tenders be scrapped in that way? Senator, if we go to the market for a tender and we do not have suitable responses, we may well do that into the future. I think it is a fairly accepted commercial practice. It is not something we would like to do because we would like to get on with the job as well, but not to the extent of taking something that is not suitable to our needs. Senator MACKAY—Let us go back to this baby bonus issue for a short period. I am going to ask a series of very quick, short questions and then we are going to move on. ACTING CHAIR—Have we finished with the IT people? Senator MACKAY—Yes, that is definite. ACTING CHAIR—The IT people can be discharged. Thank you. Senator MACKAY—The interdepartmental task force report says at paragraph 107: It would be costly and in many ways unnecessary to introduce a paid maternity leave scheme in addition to the current baby bonus scheme. I do not expect you to comment on that but I will ask the following question: has Treasury costed the option of abolishing the baby bonus and replacing it with a form of paid maternity leave?

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Mr Tune—I do not think I can answer that, Senator. I think you are delving into policy issues and advice that we may or may not have given the government, regardless of whether or not it was in the context of the work and family task force. Senator MACKAY—Just to reiterate, in the 2003-04 PBS, Treasury revised down the cost of the baby bonus from $80 million to $60 million in 2002-03, and from $250 million to $170 million in 2003-04. Would it be a reasonable expectation that the forward years would be revised down by similar proportions? Mr Smith—We do not have any information that we can give you on that, Senator. The government has not elected to publish forward estimates of those revisions. Senator MACKAY—When you say ‘the government has not elected’, presumably the government has determined that they will not be published? Mr Smith—As I said earlier, the portfolio budget statements provide two years and it is not usual to provide any more for any program. It is also not usual for us to revise costing estimates for any tax program. The baby bonus is an exception in the sense that of course it is actually an outlay, not a tax. Senator MACKAY—Why can’t forward estimates be provided for a program that is administered? Mr Smith—There is very significant cost in providing revisions to estimates of tax measures, and there is also a lot of difficulty in doing so. There is a lot of cost in providing estimates of any program. As you may know, many years ago we did not provide any forward estimates, full stop, but gradually over the years more and more information has been provided. You are asking for a further step to be made that has not been made, to my knowledge, by governments. Maybe the day will come when they will but at this stage that has not been the practice. That is a broad statement. If individual ministers in individual areas wish to provide more information about individual situations, that is a discretion that they have. Senator MACKAY—Thank you for that. What is the number of baby bonus claimants that have been rejected because (a) the form was filled out incorrectly or (b) the wrong base year was nominated? Do we have that information? Mr Carmody—We would have to take that on notice. Senator MACKAY—What is the number of complaints the department has received by claimants who have had their applications rejected? Do you have that offhand? Mr Carmody—I doubt that I would have that offhand, Senator. Senator MACKAY—This is on notice again. I understand why. Mr Carmody—It is a very specific— Senator MACKAY—No, I do understand why. I am alluding to the previous discussion we had about previous questions on notice, that is all. I understand that. Can you take on notice how many claimants originally rejected have subsequently had their claims accepted, or are you aware of that figure? Mr Carmody—I would not have that figure, Senator.

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Senator MACKAY—Can somebody describe to me briefly what the process is by which the ATO ensures that claimants entitled to the baby bonus actually receive it. Ms Vivian—Senator, your question was how do people receive the money once we process a claim? Senator MACKAY—Yes. Ms Vivian—Basically, once their claim is lodged with the Australian Taxation Office, we process it. There are two ways people can claim it—as part of their income tax return, or they can lodge a separate claim if they do not have to lodge their own tax return. Assuming it is lodged with their tax return, the baby bonus is processed and is sent out with their assessment notice. If it is lodged as a separate claim, the baby bonus is processed, put through our computer, and we produce a notice and send out a cheque with it or advice about what the amount is. Senator MACKAY—I am going to have one more go on this issue. Why has $105 million apparently been underspent on this? Mr Gallagher—You are comparing that to the original forward estimates. Senator MACKAY—That is correct. Mr Gallagher—At the time we produced the original election costing of the baby bonus, we said that the estimate assumed 100 per cent take-up and that that was unlikely to be the case. It was always going to be the case that we had a maximum costing in the forward estimates and that the reality would fall somewhere short of it. Senator MACKAY—That is a pretty substantial shortfall, isn’t it? Is that normal? Mr Smith—I do not think we could say what is normal for take-up for any particular program when it is a unique program. Mr Gallagher—Take-up is very difficult. When something is new and has never been done before, you do not how it is going to go. When the costing was done, there was no knowledge at all about the way it would be administered. Senator MACKAY—No knowledge at all? Mr Gallagher—No knowledge about the detail of the administration. Obviously, you are costing months before there is any draft legislation or any consideration of administrative systems or anything of that nature. Senator MACKAY—I get the picture. Mr Smith—Could we add to the answer we gave previously in relation to the case? The person whose baby is born just before midnight gets the same claim as the person whose baby is born just after midnight in respect of the following year. In other words, I do not think that there was anything of substance in that example. Senator MACKAY—What I might do is provide details on notice of other examples that I have here for response; otherwise we are going to waste time. In the ATO’s experience, do small businesses generally find it more difficult to comply with their GST obligations than big businesses?

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Mr Carmody—We find, as a general proposition, be it GST or income tax—or across the range of income taxes—that large businesses are clearly better resourced and better positioned to manage their tax affairs. I think some years ago there was research done into the costs of various income taxes and the cost of complying with them, and that showed—again, nothing surprising—that small businesses faced more difficulty because they did not have the same resources available to them. However, we have done tracking research, which you might have seen reported in the newspaper, which has shown that small businesses are increasingly in a position to complete their GST obligations, and obligations under the new tax system are becoming more routine. Senator MACKAY—Is that the reason why there has been a move in the ATO from an education approach to a more rigorous compliance approach in the last 18 months? Mr Carmody—That was a natural progression. On the implementation of any new initiative, the initial phase is to make sure that people understand their obligations. If you want people to comply with a new measure, the best way to do that is to get them to understand what their obligations are. There was a huge investment in the introduction of the GST and other elements of the new tax system, but, two to three years on, there needs to be a rebalancing of that. About 18 months into the system, we started to see a drop-off in people lodging on time, and that indicated to me that the time was right to start to rebalance our approach. While there has been a fair level of commentary on our compliance activities and their firming up, we still offer an extensive range of assistance. For new businesses, particularly, we offer the opportunity for visits to their premises to help them set up and so on. Even though I have described it as a rebalancing, we have not given up on assistance. Senator MACKAY—Would it be fair to say that the honeymoon is over? Mr Carmody—That is the sort of thing that you would see in newspapers! Senator MACKAY—Generally, you believe that it is now time to— Mr Carmody—Yes, and progressively we have done that across the board. Senator MACKAY—Are you finding that many small businesses continue to have difficulty with complying? Mr Carmody—We find that people at times are not complying because they do not fully understand. I think in the annual report there is a reference to the levels of penalties applied, reflecting the policy I had of saying, ‘In the first two years, we understand you are coming to grips with something and we understand at times there will be mistakes.’ We reversed the onus and said we would not apply penalties unless there was clear evidence that they had been out to ‘rort the system’, to use another newspaper term. I think it was only in about two per cent of cases that we applied penalties. Again, that balance is going to change, but clearly in the implementation period people had to adjust and come to grips with a new tax system. Senator MACKAY—What is the percentage now? Mr Carmody—I do not have the latest up-to-date figures, but that percentage will probably remain reasonably high. When we go out for an audit, we will sometimes look back

ECONOMICS E 146 Senate—Legislation Thursday, 19 February 2004 to previous years. Even though we might be doing an audit now, if the audit relates to that first period of implementation we would apply the same policy. Senator MACKAY—Presumably, it is higher than two per cent at this point. Mr Carmody—I think it is probably moving up, but it is not dramatic yet. Senator MACKAY—I would like to bring to your attention a particular case of one small business, to illustrate the effect that BAS compliance and the ATO’s enforcement is having on small business, and ask you to comment on it. Mr Aitken—this is a person who has written to us—is in the process of setting up an export business. It is called Environmental Organics Australia. He has submitted 27 BAS forms and, because he had not been trading and had not, therefore, GST to remit, he simply wrote on top of the form, ‘Nothing to report.’ After 27 months of submitting BAS forms in this way, Mr Aitken—fortunately for him—did have something to report. He had started trading and submitted a BAS form with the relevant information and the correct amount of GST. At that time, the system appears to have picked up the fact that he had not filled out his BAS forms correctly for the previous 27 months and he was issued with a fine, plus interest penalties, which is now worth $13,000. Mr Carmody—I do not understand why. Senator MACKAY—It does seem bizarre. Mr Carmody—I am quite happy to have a look at that case, but I do not understand why that would be the case. Senator MACKAY—You can see where I am going. It was not deliberate. He had paid the right amount of tax when he was actually a taxpayer. Mr Carmody—If it was not deliberate and he put the ‘nil’ in the right place, he should not have penalties applied to him. There might be other circumstances we do not know about, but I am more than happy to look at the case. Senator MACKAY—With that proviso, I accept that. Generally, this would not be an acceptable situation. Mr Carmody—Subject to that caveat, it would not be what I would expect and I am happy to have a look at the case. Senator MACKAY—We will provide you with the details. Can you provide a breakdown of the number of penalties associated with filling out the BAS forms—and you may take this on notice—in particular, failing to lodge, late lodgment, late payment, insufficient information and inaccuracy. Is that possible to segregate? Mr Carmody—I will have to take it on notice. Senator MACKAY—I understand that, but is it possible to segregate along those lines? Mr Carmody—We can certainly look at late lodgment and non-lodgment, because we have been putting a lot of effort into that. I am not sure that there would be penalties for incorrect information, unless someone was trying to misrepresent their position, but I am happy to take it on notice and see what we can provide for you. Senator MACKAY—I would certainly like to know what happened to Mr Aitken.

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Mr Carmody—As I said, I would need to look at the circumstances to understand why that occurred. Senator MACKAY—What can you do? You can do late lodgment and late payment? Mr Carmody—We can certainly do late lodgment and late payment. Senator MACKAY—Failing to lodge? Mr Carmody—I will give you whatever information I can about those cases and any others of the sort you talked about, in relation to the penalties for supplying misinformation. Senator MACKAY—Could you do that in a percentage form as well. Mr Carmody—Yes. It will be a pretty low percentage. Senator MACKAY—I understand. Mr Carmody—We get millions and millions of activity statements. Senator MACKAY—I only ask the questions! Mr Carmody—Yes. Senator MACKAY—Would you also take on notice what percentage of these breaches are found to involve businesses not remitting the accurate amount of GST? Mr Carmody—Yes, I will. Can I just say on that, where we see refunds that look unusual, we will hold them up. We may adjust them, but they are a very small percentage, again, of the totals that go through. Senator MACKAY—I want to ask some questions about the Switzerland exchange of information agreement. ACTING CHAIR—Before we move to that, has any further work been done on simplifying the BAS statement? Mr Carmody—We have certainly put a bit of effort into providing more and more customised BASs. I think someone told me that we have 27 different versions of activity statements now, as we have tried to tailor them down, rather than having—I do not think this was ever the case—one that covered every possibility that might apply to a business. We now have, as I said, something like 27 tailored activity statements. Certainly there has been effort put into that. That is about all I can say at the moment. ACTING CHAIR—Some time ago, when I asked about the need for capital expenditure given the different levels of what capital expenditure is for large and small businesses and STS and that sort of thing, you indicated then that it was necessary because you could have a large amount of refund and that could hold up the refund. Mr Carmody—Yes. ACTING CHAIR—Why would it be the case that it would hold up the refund? We presume taxpayers are honest. Mr Carmody—We presume they are honest. We have reasonable checks to verify that at times. ACTING CHAIR—Yes. Is that sufficient, to do that analysis?

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Mr Carmody—The position, at a broad level, is that we have to also balance attempts to claim false input tax credits and correct refunds. When I say this, I am not saying anyone we check is guilty of this; in fact, the bulk are not. You would know we have quite a program on that. Another senator might sit in with you one night and say we are not doing enough of that. That is the balance we have to strike between getting refunds out to people and ensuring up- front that if there are refunds that look disproportionate, they are checked. The reason for the capital expenditure, as advised to me, when I spoke to you, was that you will see a pattern from someone who is paying amounts and then, all of a sudden, there will be a very large refund. That is the sort of thing that we would normally check. Having the capital expenditure on the activity statement enables us to say, ‘Okay, we understand why that’s the case,’ and if it matches their business we will not hold it up. But if we did not have that, then we would have to start checking with the taxpayer: ‘How come, all of a sudden, you are claiming this large refund?’ ACTING CHAIR—But in a sense that is departure from the self-assessment principle, where you lodge your return and an assessment is made, or a refund is made and then, if need be, an order follows up. Mr Carmody—That is not my view of self-assessment. ACTING CHAIR—Isn’t it? Mr Carmody—That is certainly how it works in the bulk of cases, but self-assessment— ACTING CHAIR—Perhaps you should explain the new view of self-assessment. Mr Carmody—That is the view I have. My view of self-assessment—and I have said this publicly on a number of occasions—is that basically self-assessment is a risk management process. The reason for self-assessment was that prior to self-assessment we theoretically— and I say theoretically because we never had the resources and you would never be able to do it—checked every return. That made no sense, if I accept what you are saying, and I do—that most people are going to do the right thing. You are spending all your resources checking up on everybody, and it does not make sense. It restricts your ability to get out and find out from those who are trying to do the wrong thing. In any event, you are only dealing with paper information that is given to you. If you accept it is risk management, then, yes, the basic approach is to accept what is there and then audit later, but you do not turn a blind eye, under risk management, if you have received something and it looks ridiculous. ACTING CHAIR—No, that is right. Mr Carmody—And that is, in a blunt sort of way, the principle we apply. We do run a number of checks, for example, for refunds that look disproportionate, too high, whether they are income tax activity statement or otherwise. To take it a step further, we monitor very closely our large corporate collections. Under the system, they come in regularly and they are based on trading conditions these days, and it is not unusual for us to go out and talk to a corporation, even before they lodge their annual income tax return, if we see that their instalment payment is substantially out of kilter to what we would have expected. Again, it is not a black-and-white issue of just accepting everything that is put before you. ACTING CHAIR—So the allegation that you are holding back on credits is not true?

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Mr Carmody—We get out something like 93 per cent to 95 per cent within 14 days. That does mean there is five per cent or so that we hold up. I would say, however, that the bulk of the hold-ups are because people have not provided bank details and so on to issue the refund to. But that is a pretty high percentage that we get through, and we try and balance those competing factors that I have talked about. ACTING CHAIR—The bank details are provided on the— Mr Carmody—People need to provide account details for payment of refunds in a range of circumstances. ACTING CHAIR—Thank you. Senator MACKAY—Just going back to this issue of Switzerland exchange of information agreement, it is an issue the minister is obviously aware of. What was the date of the last negotiation between Australia and Switzerland on an exchange of information agreement on general tax matters? Mr Carmody—We have a comprehensive double tax agreement with Switzerland, which includes certain exchange of information, but, as you are probably aware, there are limits on what Switzerland provides. Senator MACKAY—Yes. Mr Carmody—That is a fairly old agreement. I do not know whether Mr Duffus has specific detail on that. Mr Duffus—From memory, it is 1989 or very early 90s. Senator MACKAY—Let me just background it for you. As I understand, in answer to a question on notice at the November estimates it was indicated that there had been a recommencement of negotiation on the existing treaty in the mid-1990s; however, negotiations have stalled. Mr Carmody—Had failed, yes. Senator MACKAY—Senator Coonan, I think, indicated that the government would negotiate an exchange of information agreement with Switzerland. Mr Carmody—I do not know about that. Not to my recollection. Senator MACKAY—I think it was in a response to a media release from the shadow minister for revenue. Senator Coonan—You might just have to show me, Senator Mackay. I do not immediately recollect it. Senator MACKAY—It was in the Financial Review. Mr Carmody—I think there are some issues around the potential for renegotiation of the total double tax agreement, but I am not sure of the specifics. Senator MACKAY—All right. Let us try to truncate this process. Has anything happened on that front?

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Mr Smith—The Treasury has a treaty program. The Swiss treaty is one that is, as I think has been mentioned, rather old. There are a large number of issues in relation to it, but I do not think we are at the stage yet where we have advanced very far with negotiations with them. Senator MACKAY—Have negotiations been opened or not with Switzerland? Mr Smith—I do not know what the state of play on that is. I think there has been some contact between us, but I am not sure what it is. I will have to take that on notice. Senator Coonan—I will just see if I can find it. Senator MACKAY—Thank you. Specifically, I just advise the officers that there was an article that I am relying on in the Australian Financial Review on 13 February this year. Maybe I could ask Mr Smith: has there been anything happening in the last week with the Swiss in respect of this? Mr Smith—I have to take that on notice. Unfortunately, my treaty people are not with us tonight. Senator Coonan—Senator Mackay, I can throw a little bit of light on that matter that you raised with me. I am advised that what was being referred to was as a result of the treaty negotiations with the United States. That is a trigger then that we now negotiate with the Swiss. A key feature of those negotiations would have been exchange of information. I do not know whether that is quite what you have in front of you, but I am advised that is probably what you are seeking. Mr Smith—Switzerland is one of a number of countries—the UK was another and we have completed the treaty with the UK—which had treaties with provisions that were triggered by the US treaty change. I do not think that Switzerland is, at this stage, fully cooperative in relation to the idea of fundamentally changing its approach to information exchange. That is a matter which, of course, has been the subject of processes at the OECD and elsewhere. Senator MACKAY—Yes. Mr Smith—Whether or not there has been any progress specifically in the last week, as I said, I will have to take on notice. Senator MACKAY—I do appreciate that you do not have your responsible officer here. Can I assume from your previous answer that there has been some preliminary contact with the Swiss on this? Mr Smith—I do not know when or in what form. Senator MACKAY—Not necessarily in the last week. Senator Coonan—There were some earlier answers given by Mr Lucy, who was there on behalf of ASIC. There were some communications, but I do not know whether you would formally call it an exchange of information. He gave evidence yesterday about some meetings and that, I think, probably gives you as much updated information as we have. Mr Smith—We can give you an update on the state of that discussion with Switzerland when I can get back to the people.

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Senator MACKAY—Thanks for that. Is the ATO aware that subsequently the US, Finland and Germany have signed more comprehensive treaties with Switzerland than Australia has? Mr Duffus—I am aware that those exchange of information type agreements have been negotiated with those countries. All they do is try to explain in more detail the definition of ‘fraud’, which is the major issue that we face, which is linked to the whole notion of bank secrecy. The US, in particular, have in their treaty now more specific examples of fraud. At the same time, the Swiss put out a press release saying that in their view that negotiated treaty does not change the way they have applied their domestic laws. Senator MACKAY—Minister, are you aware of anything that your office has told the media about the nature of these negotiations, or any negotiation, in the last week? Would you like to check? Senator Coonan—I do not have my media people here, but I will certainly take it on notice. Senator MACKAY—In the tax office’s response to Senator Sherry’s question on notice about tax havens, from the last estimates meeting, it states that there is no way of telling how much money flows from Australia to New Zealand and on to tax havens such as Nauru. Does New Zealand have the Australian equivalent of AUSTRAC? Mr Duffus—No, Senator, they do not. Senator MACKAY—Can New Zealand track the flow of funds to other countries? Mr Duffus—I am not aware, but we do have an exchange of agreement arrangement with New Zealand, where we can ask them for further information from funds that flow out of Australia and which go on to other countries. They have some mechanisms, but not the AUSTRAC arrangements that we have. Senator MACKAY—I assume that this information will assist the ATO in tracking flows of funds and picking up illegal activity. What action has the ATO taken to date to get New Zealand to address this issue specifically, given we have just received the question on notice? Mr Duffus—The broad issue for us is exchange of information that we do have with New Zealand. New Zealand is the major country where we have exchange of information. They are the dominant country that gives us data, followed closely by the UK, and we are very active in exchanging not only automatic data with New Zealand—that is, data around dividends and the like—but also quite significantly specific data on cases that we see and, likewise, from them. Senator MACKAY—Wouldn’t this constitute a major hole in the ability of the tax office to ensure compliance with Australian laws? Mr Duffus—Clearly, it is a block for us that we do not see where data goes after it goes to another country. Senator MACKAY—Yes. It is New Zealand, and you were saying that it was— Mr Duffus—If we were able to get data from them that showed funds that went through a country to another country, that would certainly make it easier for us. There is no doubt about that.

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Senator MACKAY—I am sorry to repeat that question. I apologise if you have answered it. Has the tax office approached New Zealand in terms of assisting them to undertake the sort of tracking that occurs here? Mr Duffus—Not to that level. As I said, we have significant liaison with the tax office in New Zealand about flows of funds to other countries. Senator MACKAY—Has there been anything more substantive than a general exchange of information? Mr Duffus—Not beyond the requests that we make to the country. Mr Carmody—But they do go to cases that we have. We have talked about risk management before. They do go to cases where, on the indications of the transfer or the parties involved or whatever, we might have suspicions. It would be a perfect world for us if we could get information about everything in the world. We do not live in that perfect world, but certainly advances are being made, even in the area of tax havens. You would be aware that there is an initiative now where many of them have signed up to an OECD initiative. We have had negotiations with one tax haven already and we have three more coming up in the next few months. Three of those are three of the biggest recipients of funds flowing out of Australia. Advances are being made. Senator MACKAY—I do appreciate that. The comment I would make is that, given the close economic relationship between Australia and New Zealand, I would imagine this would be a very high priority for the tax office. Mr Carmody—Yes. We do have, as Mr Duffus has said, pretty close relations with the New Zealand revenue authority; in fact, the commissioner of the New Zealand revenue authority is a former employee of mine and we do liaise very closely. We will, as necessary, improve that as we see the risks. Mr Duffus—It is also worth noting, Senator, that the importance we are placing on exchange of information has seen both us and New Zealand negotiating these agreements with the haven countries. We are negotiating those jointly. Senator MACKAY—I might come back to that, but I will move on to disclosure of foreign bank accounts. In answer to a question on notice from the November 2003 Senate estimates, the tax office said that there is ‘no means of establishing the extent of the use of Swiss bank accounts by Australians’. Does AUSTRAC? Mr Duffus—No, Senator. AUSTRAC only monitors the flow of funds out of Australia and back into Australia. Bank account information is protected by the bank secrecy laws in Switzerland so that the equivalent of the tax office in Switzerland cannot get information, and they would be the ones that would exchange the information with us. They have no access to the data. Mr Carmody—Unless there is criminal fraud involved. Senator MACKAY—Can the ATO or AUSTRAC collate AUSTRAC data to determine which Australians are likely to be operating foreign bank accounts?

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Mr Duffus—We can collate just the sources of funds leaving Australia. We do not know whether they are going to a bank account; they could be just going to a person. Mr Carmody—To complete that, when it comes to Switzerland, for example—I assume your focus is still on Switzerland—we do have details of who is transmitting this money, and therefore there is an entity in Australia. We are able, if we are concerned about it, to pursue it at this end. There are large pharmaceutical companies in Switzerland, there is a lot of tourism, and the vast bulk of the funds that flow to Switzerland is related to very large corporations that would be part of our very close risk analysis. It is not a black box. The fact that we have the funds flowing from here out gives us an ability to start. Be it Switzerland or wherever, if you get to what look like serious attempts to avoid tax and we are not getting full information, we do have the ability, based on a reasonable basis, to raise default assessments against the entity in Australia, if we believe that they are concealing income or whatever. As I say, it is not a black box. Senator MACKAY—Also in response to the question, the tax office said: It would be advantageous for the ATO to know which taxpayers are operating Swiss bank accounts for compliance monitoring. Does the ATO have the power to require a taxpayer to disclose whether they have a foreign bank account? Mr Carmody—If it is reasonably based, related to their taxation affairs, we have the ability to require information, as a general proposition. Senator MACKAY—Do you do that? Mr Carmody—I am not sure of the detail of that. I can only answer about the powers we have. Senator MACKAY—You have the capacity to do that? Mr Carmody—To slightly broaden it and to illustrate our powers, when it comes to funds flowing out of the country, we do. I know that, where a financial institution is involved, we do exercise our powers to gain information, to get details of those flows of funds where we are concerned about them. Senator MACKAY—You can enforce it? Mr Carmody—Yes. We can enforce that level of information in relation to taxation affairs in Australia on an entity in Australia. You remind me, Senator, that we have sent out or are in the process of sending out something like 1,000 questionnaires to taxpayers where, on analysis of AUSTRAC data and flows of funds, we are asking them a series of questions about what those funds relate to; where they have gone. I suspect that might include questions about accounts or whatever but I would need to check that. Senator MACKAY—What are the 1,000 letters or questionnaires based on? Mr Carmody—That is based on a risk analysis and that is probably at the smaller end of the market because the vast bulk of funds that flow to tax havens have to do with legitimate trading or currency dealings—and we have provided information to this committee previously. As I said, with Switzerland, the vast bulk we can trace to major corporations

ECONOMICS E 154 Senate—Legislation Thursday, 19 February 2004 dealing. They are subject to very close risk scrutiny. But as we have gone through and we have sought to categorise lumps of these amounts that flow out of the country to havens, there are some—they are not necessarily very large amounts—that seem to be dealings by individuals which we cannot readily explain in our minds or cannot rationalise. Perhaps that is a better expression. Senator MACKAY—So there is a prompt along those lines. Mr Carmody—Therefore, we are in the process of issuing about 1,000 of those questionnaires. Senator MACKAY—Could you take on notice how many times you have pursued this process in, say, the last year, if that is okay. Mr Carmody—We can give you details of the activities we have taken in that area. Senator MACKAY—Could the ATO make it a requirement that taxpayers reveal any foreign bank accounts on their tax returns? Mr Carmody—We already have requirements: on things like dealing with related parties on transfers overseas, we have schedules related to that. I would need to examine the proposal because there are also issues. You need to balance out the issues and I would need to look at that, Senator. Senator MACKAY—I am talking about an actual bank account number. Mr Carmody—Yes, I understand. Senator MACKAY—You can take that on notice. I am going to talk about share buybacks. These questions struck me as being a pretty good idea, I have to say. ACTING CHAIR—Have you given any consideration to assisting taxpayers by including on the return an indication of the TaxPack or bulletin which might be relevant to the completion of that particular item of revenue or expenditure? Some taxpayers have to refer to about six or seven different documents, depending on their classification of income. Mr Carmody—Yes. ACTING CHAIR—Have you given consideration to putting a cross-reference on the income tax return? Mr Carmody—First of all, the bulk of people go to tax agents and they have a level of knowledge that we would expect. Secondly, for the increasing number who use our e-tax product—I am not sure of the exact detail—increasingly you can click into further information so that it is there in front of you. Of course, the design of TaxPack is not to go straight to the formal return form. It is actually to work through the series of questions in TaxPack, and if you do that, it directs you to where information is available if it is not already included on TaxPack itself. They are the design features we have. Senator, the questionnaire does not specifically mention the account but, more significantly, it asks a number of questions, like the names of parties involved, the addresses of those parties involved, the nature of the relationship between the parties, the date of the transaction, the amount, the jurisdiction, the nature of the transaction, a detailed description of

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 155 the purpose of the transaction. It is at that level of detail that we are examining those, which I think are the material questions. Senator MACKAY—I do not know if you want to take on notice or you feel you have adequately answered the question about what prompted sending those 1,000 letters out to those specific parties. Mr Carmody—I am not sure that we can give you any more than that. We could not understand why, on the face of it, they were occurring, and they seemed to be personal transactions. Senator MACKAY—Just on share buyback, what precipitated the ATO change of mind on the tax treatment of share buyback in its draft tax determination released on 14 January? I have the reference number here, if you would like it. Mr Carmody—No, I am aware of it. Senator MACKAY—I thought you might be. Mr Carmody—It was precipitated—if I can be candid—because I had a close look at the law and was not satisfied with the answers that had been given to me. Senator MACKAY—Fair enough. Do you have any idea how many private rulings the ATO has given in the past two years with respect to share buyback schemes. Mr Carmody—I do not have that detail here, but most of them have been public and I do not know that there have been that many of them. It would be fairly standard for a company entering into a buyback to approach us. It is not a huge number. Senator MACKAY—All right, maybe just take that on notice for completeness. Mr Carmody—Yes, I will take it on notice. I am sure we can provide that. Senator MACKAY—Can the ATO provide an estimate of the total revenue difference between the more generous private rulings it provided to companies, including Telstra specifically, Woolworths and Fosters? What would have been collected under the new draft determination? Mr Carmody—I would have to take that on notice to see whether we could provide that sort of information. Of course, it does go to capital gains and so there are questions of whether people had other losses that go through it. It might be difficult but we will provide whatever we can with whatever qualifications we can. Senator MACKAY—Would the revenue be less with the application of the new— Mr Carmody—Would the revenue be less? I would have to take it on notice to see what the detail is, and whatever we can provide we will provide. Senator MACKAY—All right. I now want to talk about GST and property. Mr Carmody—GST and property? Senator MACKAY—GST and property—scams, rorts, whatever. Mr Carmody—Market schemes and joint ventures and all that?

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Senator MACKAY—Yes, that is it. Mr Mann is the appropriate officer. What prompted the ATO to issue a taxpayer alert on the avoidance of GST on the sale of new residential premises? Mr Mann—We had become aware of arrangements in an attempt to avoid GST on the sale of new residential premises through the use of GST joint venture provisions, as a result of our audit activity. Basically the arrangements revolved around, if you like, turning the first sale of new residential property into a tax-free sale rather than input tax sale. We are in the process of auditing a range of companies. We also have arrangements in place to identify other joint ventures that we believe may be at risk for being part of that arrangement. Senator MACKAY—When did you first become aware of these schemes? Mr Mann—I cannot give you an exact date, but certainly about June last year we were aware that there seemed to be some problems. Senator MACKAY—How many companies are you auditing? Mr Carmody—Sorry, can I say we also made it public then, before the alert. Senator MACKAY—Yes. Mr Mann—We have a range of audits covering joint venture arrangements and other property arrangements that we just wish to verify; all-up there would be about 18 audits under way into these arrangements. As I say, there are over 300 other companies being monitored at this stage, or arrangements being made to— Senator MACKAY—Monitored? Mr Mann—Yes. Senator MACKAY—How many projects have been identified by the ATO as displaying the characteristics of these schemes? Mr Mann—Until we verify those arrangements— Senator MACKAY—Yes, I understand there is that proviso. Mr Mann—Taking up Senator Watson’s point, I really cannot presume whether or not those arrangements are doing anything outside the proper use of the joint venture provisions. Senator MACKAY—Broadly, what is the minimum time it would take between the ATO becoming aware of a scheme and issuing a taxpayer alert? Mr Carmody—That varies significantly. I am talking about balancing tonight. We do need to be careful, because an alert puts something out before we have a concluded view. Senator MACKAY—I appreciate that. Mr Carmody—We have to be careful about our impact in the marketplace, because if we come out with an alert, there are obvious potential impacts on commercial and other activities. It is inevitably a balancing act and sometimes it takes longer for us, from the point where we have some notion that something is going on until we are comfortable enough to be in a position where we feel comfortable going out into the marketplace and saying that. I cannot give you a precise answer. Sometimes we get on to something and we have the full detail and

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 157 sometimes we just have a sniff of something and we have to do some work before we put an alert out. Senator MACKAY—Presumably the characteristics are so diverse that it is impossible to— Mr Carmody—They are. If you have a look at the alerts we have put out, there is a great variety of them. Senator MACKAY—That is fair enough. Now I have an industrial relations matter. It is in respect of an ex-employee of the tax office called Joanne Oudshoorn. Does anybody know anything about this? It is a human resource type of issue. Mr Carmody—It does not look like it, Senator. Do you want to describe the case? Senator MACKAY—Yes. I might have to give it to you on notice. Essentially, what seems to have happened with her is that her employment was terminated following allegations about her use of working from home provisions. She is alleging a serious denial of natural justice in respect of the process issues that led to her dismissal. It seems that the AIRC made a determination that she be re-employed and that this has not been done, I am advised, by the tax office. But if nobody knows about— Mr Carmody—It does not come to my mind. It might have been somewhere, but I would have to take it on notice. Senator MACKAY—That is fine. Perhaps if I provide you with more detail on notice. Mr Carmody—Yes. Senator MACKAY—I want to ask about temporary residents who have departed Australia and tax collection. Mr Carmody—And superannuation? Senator MACKAY—That is it. Mr Carmody—That is it? Senator MACKAY—That is it. Mr Carmody—We have been dying to answer this. Senator MACKAY—And there is one brief I have missed, so I will have to come back to that. I apologise. We are tracking very well. ACTING CHAIR—What do you mean by that? Senator MACKAY—We are going to be finished very quickly, shortly. ACTING CHAIR—Very good. 10 o’clock? Senator MACKAY—I do not know. Do not push your luck here! Let us do the super question. What was the tax revenue collected from this measure in 2002-03? ACTING CHAIR—Which measure? Mr Carmody—Tax revenue? Senator MACKAY—Temporary residents who have departed Australia tax collection.

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Mr Carmody—I do not believe we have published that figure. Senator MACKAY—Why not? Mr Smith—Basically, it is for the same reason I gave earlier. I can take it on notice if you would like us to obtain that information, but I would have to put it in the context of that previous answer. Senator MACKAY—I am completely confused. Why wouldn’t you publish this? Mr Smith—Basically, this is part of the revenues collected from superannuation as a whole. It relates to the degree of disaggregation of the different elements of the revenue collection head that is provided in the government statements. Essentially, what is provided is the total amount collected from superannuation, but it is not usual to break up those total collections from superannuation, or from anything else, into their many constituent parts. It has not been published because it is not traditional to make that break-up. This is, essentially, just a component part of the overall collections from superannuation taxation. We would not, for example, publish how much we collected from people in Tasmania or any other policy or non-policy break-up, unless there was a particular reason to do so. That is the broad answer. As I say, the government has not published the separate figures, but there was an original estimate. Senator MACKAY—That is correct. It was $70 million. Mr Smith—That is what happens with all measures. We do an original estimate, but we do not usually go back and attempt to publish the revisions each year to estimates for measures which affect a broader revenue head. That is the usual view of that sort of thing. Senator MACKAY—I am advised that the projected figure was $70 million. Mr Smith—It was $70 million in 2002-03—that is correct—and $110 million in 2003-04. It then fell back. That was an unusual year. Basically, it was about $70 million per annum. That has been downgraded since then, but the government has not published the separate estimate. Perhaps they can take on notice your request for them to do so. It is not in my power to do so, other than through that mechanism. Senator MACKAY—Have the forward estimates of projected revenue for future years now been amended to reflect the actual situation? Mr Smith—There has been a downward revision in that head, based on parameter adjustment, but it has not been published. Mr Gallagher—On page E97 of the Hansard for the November estimates, I said that the estimates had been revised downwards in the estimates process. Senator MACKAY—By how much? Mr Gallagher—I did not say how much. What I said at the time was that it was an unpublished number and I would take it on notice. Senator MACKAY—How much has it been revised downwards by? Mr Smith—Perhaps if you have ask the question eight ways the answer will miraculously appear in the same form as the first.

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Senator MACKAY—Senator Sherry will admonish me severely if I do not, let me tell you. Mr Gallagher—The questions you are asking correspond to supplementary question No. 57 asked at the November estimates, and an answer has been provided. Senator MACKAY—I am going to have to allege that this has been covered up to avoid embarrassing the government. Mr Smith—As I say, we have disclosed what we can, and we are not refusing to disclose more; we are taking it on notice, if that is what you are asking us to do. Senator MACKAY—I suspect I have no choice. What was the basis of the original projection? That you can answer. Mr Gallagher—The original costing, which I think was probably an election costing for the 2001 election, looked at 48 visa classes, as I recall—which were all the eligible visa classes—and assigned likely coverage rates and likely salaries, on the basis of judgments, to those to form an estimate of the potential superannuation coverage of those who were in those classes. There was some allowance for how many months they might work. Obviously, people who are here on a temporary basis do not work all the time. That was the basis of the original estimates. There was no particular allowance in those estimates for administrative systems, because they were far into the future and essentially unknown when we attempted the costing. Senator MACKAY—What was the assumption for super contributions from temporary residents year by year? Mr Gallagher—I would have to take that on notice. I do not know that we have said particularly what the volume of contributions was, but you can work backwards. It is not the contributions that particularly matter here. It is the money they take out, rather than the money they put in. There were assumptions in the original costing about the stock of money of people in the country who had visas for more than one year and who could take out moneys from the stock, as well as moneys from the current year flow. You have to allow for the fact that some people have four-year visas. Senator MACKAY—What has been the cost of establishing the program and the ongoing cost of the program to date? Mr Jackson—I could not give you a total number like that. I can give you a sense of the number of people involved in the program. We have about 16 people who are involved in providing information, answering calls, dealing with funds, maintaining systems and the like to assist. During the formative stages of the program, we had a fairly significant education campaign—and lot of this would be on the Hansard—in three phases. The first was for people who had already been to Australia and left. We wrote to 100,000 or so of those. The second was for people who are currently in the country, and we used some mechanisms to get to those people to let them know that the capacity now existed to claim their superannuation if they were departing permanently. The third was a campaign to alert those people who were yet to arrive in the country as to the existence of this program and how it might work. I can give you a sense of the response. We have had something like 95,000 hits on our web site, with about 35,000 forms downloaded. We have an electronic system which allows a

ECONOMICS E 160 Senate—Legislation Thursday, 19 February 2004 person either here or departed to interact with the system. The system refers across to DIMIA to check that they have cleared the border. That is then referred across to the superannuation funds. The superannuation fund trustees then make an assessment as to whether the person should have the money refunded and, if so, the money is refunded and tax is withheld. We are seeing a growth in both the hits on the web site and the number of people who are filling out the departure card with their email address, which allows us to send them information. It has progressed up from something like 4,000 in the month that we started the process up to about 16,000 a month. This has been a progressive climb. There was quite a spike around the time of the education campaign in the middle of last year. This is a process of building up, and gradually temporary residents, people who provide visas and book travel and organise those sorts of events and people who are involved in providing services and support to tourists are becoming aware of this. That continues to grow. Senator MACKAY—In respect of all those aspects that you talked about—the staff allocation, the education campaign, the web site et cetera—broadly, what would have been the cost? Mr Jackson—I do not have that information. Senator MACKAY—Do you want to take it on notice? Mr Jackson—The cost for the ongoing staff of 16, off the top of my head, is about $70,000 per person. I do not have a calculator handy. Senator MACKAY—This is the tax office! Mr Jackson—It is about $1 million, plus some systems costs and the like. Mr Carmody—$1 million dollars is a rounding error to us. In fact, it does not even reach the radar. Senator MACKAY—My next question is in respect of the Sherman report. Was the Sherman report an initiative of the ATO, the Treasurer or the minister? Mr Carmody—It was an initiative of mine. Senator MACKAY—What was the scope of issues that Mr Sherman was asked to examine? Mr Carmody—To put it broadly, you are probably aware that prior to that, or around that time, I was considering new organisational arrangements to bring together those people who deal with what is commonly called in our office the pointy end of behaviour. In connection with that—and I think he was engaged in July—I asked Mr Sherman, now that I was bringing these people together, to take a fresh look at our practices and approaches and to recommend any improvements that he could see. That was the genesis of it. Senator MACKAY—Was commissioning the Sherman report a response to particular problems? Mr Carmody—No. As I said, it was in response to the fact that I was looking to bring these people together. I am not sure of the sequence, but I had signalled in our compliance program that I wanted a stronger focus in this area. Can I put it this way: sometimes there is a dilemma in the organisation, and it has come out in some of the reporting on this: are you a

ECONOMICS Thursday, 19 February 2004 Senate—Legislation E 161 law enforcement organisation like the Crime Commission? Are you are an administrator and supporter and collector of tax with civil actions? I wanted to recognise that we needed to be better targeted and have a greater capability to segment off and deal with that end of the market. We already do a lot of joint operations with the Federal Police and so on. I wanted to make sure that we were doing as well as we could. Really, it was a coalescence of things that were occurring around the time, the joining of that. Can I also say that as you move into this field you do have to deal with different techniques; you are not replacing Australian Federal Police activities but you are working closely with them and you are working in that field. Again, if I can be candid, I wanted to be careful also. I know—and no disregard to police—that when you work in that field there can often be issues about your own staff and the integrities and things you need to build around that. Every now and then there is a burst in the media where some of my staff have done something wrong, and I am on television. Senator MACKAY—Sure. Mr Carmody—That was another aspect I wanted to have a stronger focus on. It is not our traditional work. Even though we do it, it is not the bulk of the work we do, and I felt, for that variety of reasons, it would be a good time to take a fresh look at our approaches and arrangements in that field. Senator MACKAY—To the extent that, say, organised crime is an issue, is the principal criminal activity tax evasion, or is it something else like drug dealing on which tax is then evaded, or is it more general than that? Mr Carmody—You cannot be specific, but generally in these areas a lot of the joint task force work we do with Federal Police and others has criminal elements which have a tax consequence, be it the generation of income or whatever. It is a blend of those issues. Senator MACKAY—There is a suite of issues? Mr Carmody—Yes. Senator MACKAY—The suite would probably encompass the two I have mentioned. Mr Carmody—Yes, it does encompass the two. As I say, our best description is ‘the pointy end’. It is the people who are really into the organised criminal and fraudulent types of things. Senator MACKAY—What sort of tactical intelligence capability has Mr Sherman suggested that the tax office develop? Mr Carmody—The range of issues he looked at encompassed better bringing together our intelligence with that focus. As you would understand, we have to absorb a hell of a lot of intelligence and make a hell of a lot of decisions on priorities. The main thing he did was to bring a different lens to it, one that took that perspective, and then he sought to better integrate the intelligence that we get in the organisation and open up the lines of communication on that. He was also looking at the structure of our teams, bringing together different areas of expertise that had a different sense about things and different skills, to take—I forget what he called it—a whole of case approach or some description like that. We are now looking at how we structure our teams to do that.

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Senator MACKAY—Did he specifically evaluate the case load of the serious noncompliance unit and the level of resource necessary? Mr Carmody—Yes, he did come back and suggest we put more resources into it. Senator MACKAY—Yes, 157 additional staff. Mr Carmody—Something of that order. Every time I have a look at my operations, they come back with ‘More staff required.’ Senator MACKAY—Given that he came back with that recommendation—and given what you have said and putting that aside—can we deduce there is a large number of serious noncompliance risks not adequately or actively being investigated? Mr Carmody—My answer to that recommendation perhaps can answer your question. What we have done in response to that recommendation is ask them to look at the way their teams are structured and the intelligence that they use. We have also told them that in restructuring teams, if there are specific skills which require specific resources which we do not have, they should come back and we will facilitate that. When it comes to the large question of the total number of resources involved in that, what we have said—and I think this is quite logical—is that, as an organisation, we face risks right across the spectrum, and we are currently going through our planning processes for resourcing for the coming year and we will be adding that into it. Senator MACKAY—Can we deduce that the ATO is short of resources for surveillance? Mr Carmody—The surveillance activities we undertake as an organisation are generally limited to excise issues and illegal tobacco and things like that. We undertake those because that is our direct responsibility. We have certain licensing. Also the issue of chop chop is a direct revenue issue. I am very reluctant for us to embark on a range of the surveillance and other issues that are traditionally done by the law enforcement agencies themselves. My view at the moment is that we work with the Australian Federal Police, for example, on criminal issues where a joint investigation and surveillance is required. They have the skills and the ability; it is not something that the tax office has naturally got the base to do. We do that in criminal matters—putting aside the excise, which is direct revenue—through the use of the Australian Federal Police. Senator MACKAY—So it is not really an issue of extent and appropriateness of human resources, or really a question of powers, is it, in terms of what you are saying? Or is it? Mr Carmody—There were some comments in the media about us getting search warrants and other powers that come with being described as a ‘proceeds of crime’ organisation. We are not proposing that at the moment. If you are going to get into those police types of activities, my view at the moment is that for us to try and build that capability is not the best way to do it. The best way to do it is to make sure that—as we do—we work closely with the Federal Police, who can do that. They have the skills, the history and the background to do that. We will review that, but at the moment that is our position. Senator MACKAY—So you are not really in the business of becoming a law enforcement agency?

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Mr Carmody—It is always hard to say what is a law enforcement agency. We do enforce the law, and at times we enforce it very firmly. But once you move into the traditional approaches and areas that the Federal Police and Australian Crime Commission and so on are engaged in, my thinking at the moment is that for us to try and pretend we could build that skill base is not the best way of going about it. The best way is to ensure that we work cooperatively with the Australian Crime Commission and the Australian Federal Police, and we do have very close relations with them. Senator MACKAY—In the report, what are the ‘barriers to disclosure of serious crime’? What is that about? Mr Carmody—This is the question around the operation of section 3E and what we can provide to law enforcement agencies. Mr Sherman received some views which perhaps would say that that is fairly restrictive. Having seen those views, I am not yet convinced that the restrictions that are perceived are real. Before we make any approach to government about that, we will make sure that we have good practices in place and a full understanding of the powers. We are naturally an organisation that is very protective of information—that is a critical plank for the organisation—and I suspect that over time some conservatism is applied in relation to some of the information we might be able to provide to the law enforcement agencies, although I do not think we have had particular complaints from them. I think we need to work through that before we make any suggestions for changes. Senator MACKAY—In terms of any suggestions, when might that occur? Mr Carmody—It is not on the immediate horizon, because at the moment I am not convinced that we do not have the ability to do what we need to do. Senator MACKAY—Thanks for that. To finish off the evening on a high note, on political advertising, we have been advised in estimates earlier this week that there is a huge pre- election advertising campaign planned, at a cost of around $63 million. Are there any advertising campaigns planned by Treasury or the ATO to be implemented over this coming year? Mr Smith—There are none in the revenue group area, which is what I am accountable for. Depending on what you mean by ‘advertising’, I cannot be certain that there are no matters in HIH or those sorts of areas. I would have to take that on notice, but I am not aware of anything. I do not think that would be in the category you are talking about. There may be some programs for which community education or other information is required. Mr Carmody—The only one of significance that comes to my mind is the co-contribution initiative. Senator Coonan—It is not pre-election advertising, Senator. It is because the measure is coming into force. Senator MACKAY—How much is that worth? Mr Carmody—I do not think that has been finalised. Senator Coonan—I do not have the figure. Senator MACKAY—What process is that currently going through?

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Mr Carmody—It is going through the normal processes for development of those. Senator Coonan—The concept. Senator MACKAY—What is the name of that committee? I cannot remember. Mr Carmody—Yes, that committee. Senator MACKAY—A proposal has gone? Mr Carmody—I am not completely up to date on it, but it is being considered or in the process of being considered and finalised. Senator MACKAY—It has not gone to tender with respect to agencies? It is not at that point? Senator Coonan—I am not entirely sure at what stage it is, but it has certainly passed the concept stage and there may have been some time booked. I certainly can tell the committee that there is a commitment for a roll-out to advertise the co-contribution measure. Senator MACKAY—Can you ballpark the figure? Would it be $5 million-odd for the campaign? Senator Coonan—I would be guessing, and I do not think it has been finalised. There are still some matters to be sorted out. It could be misleading if I agreed with that figure. I just do not have it. Senator MACKAY—Presumably there must be some allocation for it. Mr Smith—I think the amount is still being considered. Senator MACKAY—Has the figure of $5 million ever been mooted? Senator Coonan—Not specifically with me. It could have been with people on my staff and it could have been brought somehow or other through my office. It is not a figure that I can confirm and I do not know that that is a correct figure anyway. Senator MACKAY—We will put it on notice. I forgot to ask about children’s superannuation accounts, so I will have to ask that. Senator Coonan—It would not be estimates without it! Senator MACKAY—That is right. Do you have any figures for the take-up of children’s superannuation accounts? Mr Jackson—Providers are not required to notify us of the establishment of a child’s superannuation account. The only information we have which might lead us to some view would be the surcharge reporting, where contributions are reported. We would have to look at that and confirm what could come out of that. Senator MACKAY—As you well know, because I suspect this has been canvassed many times previously—it has certainly been talked about in the Senate—there was a projected original take-up of 470,000. This was revised down to 47,000 after the election. Senator Sherry advises me that the real take-up has only been a few hundred. What are the current figures for the take-up?

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Mr Carmody—Mark Jackson mentioned that we do not have that. There is not a direct one-for-one information source that we could have. We can only take on notice that question within the parameters that Mark has talked about and see what we can provide through the minister, and get the minister to release that. Senator MACKAY—How does one evaluate the success or otherwise of this policy announcement without determining the actual number of accounts opened and using that as a benchmark? Senator Sherry has asked me to ask this. Mr Smith—Although some assumptions were made in the election costing, there has never been a target number for this program. Senator MACKAY—Was 470,000 an assumption, not a target? Mr Gallagher—That is correct. Mr Smith—Absolutely. It provides an opportunity for people to do something, if they wish, and whether they wish or not is open to them. It has never had a target. It has never been expressed that, ‘We want X per cent of children to have superannuation accounts.’ That has never been the intent. Senator Coonan—It is an alternative. It is an additional way in which people can save, if they wish. Mr Smith—It is an opportunity. Senator Coonan—I have explained many times—and you may or may not have been listening, Senator Mackay—to many questions that it is voluntary. It is not something where people are incentivised to go down a tunnel and, if they do not go, something dire will happen. It is one of the things available in a suite of measures that were brought out at the last election that have been systematically implemented. Senator MACKAY—If it is voluntary, I am curious why the 470,000 figure was assumed. Mr Gallagher—In terms of the costing, there was an analysis of the number of families with savings over a particular amount—we were using income survey data—and who, therefore, might have the financial wherewithal to do this. One-tenth of that number of families was selected as potential take-up. On the basis even of that large potential take-up, the revenue consequences of the measure were minuscule and really, in terms of the effects on the forward estimates, the program is minuscule and any variation in the estimate is of no consequence. It is well within the rounding amounts which the commissioner has cited as his own use. Even the initial revenue estimates were one-tenth of his rounding amount! Senator MACKAY—Senator Sherry has asked me to ask you a question, Senator Coonan: he says that you have said apparently at previous estimates that you will ‘talk this up’. He wants me to ask you where and when have you been talking it up? Senator Coonan—He follows every word I say; he would probably be in a better position to answer that than I would. I do, in all seriousness, think that it is a very useful addition to a suite of ways in which people can save. If someone is in a position to do so and wishes to do so, there is no reason why they should not take advantage of opening an account and getting the wonders of compound interest over a long period. But it is not obligatory. I endorse what

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Mr Smith said: it is not something where some target has been adopted. It is something that is a useful thing if people want to avail themselves of it, and in that sense I do talk about it. I talk about all of this government’s good superannuation measures. Senator MACKAY—I think I might leave you to talk to Senator Sherry about this at the next round. Senator Coonan—Senator Mackay, I just wanted to clarify one thing with you: the point about our treaty obligations to enter into negotiations with the Swiss, in effect to provide similar withholding tax outcomes to the ones that were agreed recently with the United States, which obliges us then to review the exchange of information arrangements in the treaty as a key part of the negotiations. What did you ask me to check for you: whether someone in my office was giving the current position or had talked about that obligation? I was not sure which you were referring to. Senator MACKAY—No, fair enough. I suspect what has happened is that there is some idea that someone in your office may have spoken to somebody with respect to a status report on the recommencing of negotiations on this matter. From what I can derive from our earlier set of questions, it does not seem that much has happened, but if you want to correct that— Senator Coonan—I certainly think that is right, but I now understand what is being asked and I will check whether somebody in my office said anything to that effect about the status of any recommenced negotiations. Senator MACKAY—I am sure I will be corrected in about 30 seconds if I am not right, and here again it just relates to this article in the Financial Review, Minister, in which a spokesperson indicated that there would be a recommencing of negotiations on this matter. Senator Coonan—Yes. That may well imply, just from what you have said, that there is certainly nothing much that has happened, but there is an obligation there, and that is the source of it. But I will check. Senator MACKAY—Nobody is talking to me, so I think I can happily assume we are finished. ACTING CHAIR (Senator Watson)—Thank you very much. The committee stands adjourned. Committee adjourned at 10.09 p.m.

ECONOMICS