Council of Financial Regulators Annual Report – 1998 2. Australia's New Financial Regulatory Framework

Summary of New Framework

Released in April 1997, the Final Report of the Financial System Inquiry proposed wide-ranging reforms to the structure of financial regulation in Australia, designed to achieve a more competitive, efficient and flexible financial system. The Government accepted these proposals almost in their entirety in its September 1997 response and undertook an extensive legislative program to give them substantive effect by 1 July 1998.

Under the new framework, an integrated prudential supervisor, the Australian Prudential Regulation Authority (APRA), has been established to take over responsibility for the prudential regulation of banks, previously held by the Reserve Bank of Australia (RBA), and of life and general insurance and superannuation, previously the responsibility of the Insurance and Superannuation Commission (ISC)^[1]. Supervision of building societies, credit unions and friendly societies – which has to date been overseen by the Australian Financial Institutions Commission (AFIC) under the Financial Institutions Scheme – is expected to transfer to APRA from State jurisdictions some time in 1999. When this transfer is completed, all deposit-taking institutions in Australia will be regulated by APRA under one licensing regime and will be covered by the same depositor protection provisions.

Amendments to the Banking Act 1959 have given APRA clearer and stronger powers to act decisively in the interests of depositors than were available (in the case of bank depositors) to the RBA. These include the power to revoke licences, to make prudential standards or issue enforceable directions, and to resolve the situation of an authorised deposit-taking institution (ADI) in difficulty. In such a case, APRA can appoint an investigator or statutory manager, or take control of the institution itself. It can remain in control until the difficulties of that institution have been resolved. If the difficulties prove intractable, however, APRA has the power to wind-up the institution and distribute its assets.

Under the ‘depositor preference’ provisions of the Banking Act 1959, depositors have first claim to the assets of an ADI in a wind-up. To support depositors' interests, the legislation requires that all ADI's hold assets in Australia at least equal to their deposit liabilities in Australia. However, the new arrangements do not confer any form of guarantee of depositors' funds and depositors have no recourse to APRA; nor does APRA have any obligation to make good any losses incurred by institutions under its supervision. As for ADIs, in the event of financial failure of a life company, general insurer, friendly society or superannuation fund, APRA will be empowered to intervene in the management of the troubled entity in the interests of members and policyholders (these powers are in the process of being upgraded and harmonised). In the case of superannuation, the Treasurer can levy the industry to partially compensate members for losses due to fraud, where such compensation is judged to be in the national interest. Again, however, members' and policyholders' entitlements are not guaranteed by either APRA or the Government.

The Australian Securities and Investments Commission (ASIC) has assumed responsibility for market integrity and consumer protection across the financial system. These functions are additional to those taken over from its predecessor, the Australian Securities Commission, particularly administration of the Corporations Law. ASIC sets and enforces standards for financial market behaviour and for selling financial products, including investments, insurance, superannuation and deposit-taking activities (but not lending).

As part of its consumer protection role, ASIC monitors the Code of Banking Practice, the Credit Union Code of Practice, the Building Society Code of Practice and the Electronic Funds Transfer Code of Practice. This was formerly carried out by the Australian Payments System Council, which has been disbanded. In relation to consumer protection and market integrity issues in the financial sector, ASIC now has the powers previously exercised by the ISC and by the Australian Competition and Consumer Commission. ASIC also administers the consumer-related provisions of the Retirement Savings Account Act 1997. In addition, ASIC now provides administrative support to the Superannuation Complaints Tribunal (SCT). The SCT is unique in the financial services industry, being a statutory dispute resolution scheme. As a result of recent decisions of the Full Federal Court, the review powers of the SCT have been rendered inoperable. A number of options are being considered to ensure that superannuation fund members continue to have access to a cost-free, independent and effective dispute resolution scheme. ASIC is committed to the development of such a scheme as soon as possible.

The Reserve Bank of Australia retains responsibility for monetary policy and for overall financial system stability. The RBA no longer has an obligation to protect the interests of bank depositors and it does not supervise any individual financial institutions. Its focus is now a broader one, namely, dealing with threats to financial stability which have the potential to spill over to economic activity and consumer and investor confidence. The RBA retains its discretionary role of ‘lender of last resort’ for emergency liquidity support in the event of threats to financial stability.

At the same time, the RBA has been given greatly enhanced regulatory powers in the payments system, exercised by the new Payments System Board within the RBA. These powers are aimed at promoting efficiency and competition in the payments system, consistent with overall financial stability. If the RBA, for example, assesses there is scope to improve the access, efficiency or safety of a particular payment system, it can ‘designate’ that system as being subject to its regulation. It may then, in the public interest, impose an access regime on that system and/or set standards for efficiency or safety. The Government envisaged that these powers would be exercised within a broad co-regulatory approach, with safeguards for private-sector operators. The RBA also remains responsible for conducting settlement accounts for participants in the payments system.

Annual Reports and internet web sites of the individual Council members (see page 20) contain further details about their responsibilities and activities.

Transition to the New Framework

The Council has closely monitored the transition to the new regulatory framework and is pleased with the smooth progress to date. APRA was formally established on 1 July 1998, with ISC staff and the RBA's bank supervision staff transferring to APRA's employment on that date. Re-location of staff to APRA's new Head Office in Sydney was completed by November. Assessing the scope to harmonise regulatory techniques and standards applying to banking, insurance and superannuation has been an early priority for APRA, as has the development of a comprehensive policy for prudential supervision of conglomerates. ASIC also began carrying out its expanded responsibilities under its new name on 1 July 1998.

The transition will not be complete, however, until the transfer of responsibilities for institutions covered by the Financial Institutions (FI) Scheme. The FI Scheme is a co-operative, State-based system of prudential supervision and regulation set up by the States and Territories in 1992. Uniform legislation governs the operation of building societies, credit unions and friendly societies; the first two of these groups have been covered by the FI Scheme since July 1992 and friendly societies since October 1997. AFIC is the lead regulator of the FI Scheme, responsible for the development of prudential standards, the direct supervision of Special Services Providers to the building societies and credit unions, and the co-ordination of supervision for the groups covered. Day-to-day responsibility for supervision and corporate regulation rests with the State Supervisory Authorities, which are independent statutory authorities based in each State and Territory.

As part of its response to the Financial System Inquiry, the Government endorsed the recommendation to transfer responsibility for the prudential supervision of the State-based financial institutions to APRA and the corporate regulation of these institutions to ASIC. In-principle agreement with the State and Territory Governments was reached in June 1998. To carry these reforms into effect, legislation in the Commonwealth and each of the State and Territory Parliaments is required. The first stage of legislative amendments, including changes to the Banking Act 1959, was made in June 1998 to take account of building societies, credit unions and Special Services Providers. The second stage of Commonwealth legislation includes amending the Life Insurance Act 1995 to incorporate the supervision of friendly societies and passage of the Financial Sector (Transfers of Business) Bill 1999 which will facilitate mergers between ADIs or life insurers. APRA will be able to use the latter as a quick and efficient prudential tool in cases where a supervised institution is in financial distress. Other legislation must be passed by Commonwealth, State and Territory Parliaments to wind-up each of the State-based supervisors, transfer corporate regulation to ASIC and make other necessary administrative changes.

Following extensive consultation at an official level, the Prime Minister sent a Heads of Agreement to State and Territory Governments in late November 1998 to formalise the means by which the transfer of AFIC's responsibilities will be achieved. The Commonwealth aims to achieve this transfer by 1 July 1999. In the interim, AFIC, APRA, ASIC and the State Supervisory Authorities are working closely to ensure that the transfer causes minimum of distruption for supervised institutions.

Co-ordination between Council Members

The Financial System Inquiry argued that strong mechanisms should be established to ensure effective co-ordination and co-operation between the three regulatory agencies. The Council believes that such mechanisms should aim at full and timely exchange of information, the avoidance of duplication and a clear delineation of responsibilities, particularly when dealing with matters such as a financial disturbance. The legislation underpinning the new financial regulatory framework has built in some of these mechanisms. For example, the legislation provides for both the RBA (two members) and ASIC (one member) to have representation on the APRA Board and for APRA (one member) to have representation on the Payments System Board. Legislation authorising the exchange of confidential information between the three regulators has also been passed.

In addition, less formal co-ordination mechanisms have been put into place. The Council itself provides an overarching structure. Strong bilateral links are also being built between the members, in terms of their evolving responsibilities. The framework for co-operation has been set out in two Memoranda of Understanding (MOUs) which have been signed between the RBA and APRA and between APRA and ASIC. The MOUs cover such matters as information-sharing, prompt notification of any regulatory decisions likely to impact on the other agency's area of responsibility, and consultation arrangements in the event of financial disturbances. The MOUs also establish bilateral Co-ordination Committees which aim, among other things, to avoid overlaps and gaps in regulatory coverage. Of course, at the broader level, this remains very much a focus of the Council.

The two MOUs are reproduced in Appendix B.