The Financial Services Council (FSC) has called for the government to cap compensation claims over financial misconduct at "reasonable levels" so as not to create a "moral hazard".
In a submission to the Treasury's Compensation Scheme of Last Resort (CSLR), the FSC urged the government to work with the financial services industry to ensure that CSLR compensation is targeted at areas where unpaid determinations have historically arisen.
It names these as financial advice, investments and credit.
Following the Royal Commission, the government committed to establishing the CSLR so as to ensure consumers and small businesses would receive compensation where due; where a financial service provider is found to have engaged in misconduct and the provider is unable to pay.
FSC chief executive Sally Loane raised concerns of the "moral hazard" of a scheme like CSLR.
"The FSC has long had concerns about the risk of moral hazard that can arise from a scheme like this and wants to ensure the CSLR that is established is as targeted, sustainable and as equitable as possible," she said.
"This means capping claims at reasonable levels, ensuring sectors which are responsible for the losses self-fund those losses and implementing a scheme without cross-subsidisation across financial services sectors."
The FSC argued that scheme caps, without any cross-subsidization, were required to limit this "moral hazard".
"Applying a general socialised levy could create a moral hazard, would not achieve the government's or the Royal Commission's objectives of accountability and responsibility and would not address issues such as capital adequacy and robust professional indemnity insurance for advice firms," it said.
This FSC also recommended that the CSLR scheme be "mid-coverage" and "targeted" at the sectors typically involved in unpaid compensation.
Loane argued that the CSLR scheme be funded by the specific sectors responsible for this unpaid compensation, for example, that advisers fund unpaid financial advice determinations.
"With most of the historical unpaid determinations arising from poorly capitalised financial advice businesses we want to see the introduction of adequate capital requirements and greater oversight of appropriate and strong professional indemnity (PI) insurance requirements for financial advice licensees," she said.
"The introduction of a CSLR without strengthening the regulatory weaknesses in advice will result in an incredibly costly shortcut which won't address the underlying issues leading to financial advice licensees failing to meet their consumer compensation obligations."
It recommended that data be collected to build this financial services provider funding approach.
"Unpaid determination data should be collected from the outset to enable the CSLR to move to a financial services provider risk-based funding approach as soon as reasonably practical," the FSC said.
However, Loane argued if the government did decide to introduce a cross-subsidised CSLR, then it should be funded by Australian Financial Complaints Authority (AFCA) members.
"Should the Government opt for a cross-subsidised CSLR, then cross-subsidisation should only apply to a broader general levy funded by all AFCA members where it is intended to be a resilience reserve. This general levy resilience reserve would act as a backstop to sector specific funding," Loane said.