Council of Financial Regulators Annual Report – 1999 2. Australia's Financial Regulatory Framework

Summary of Framework

Australia's current financial regulatory framework, the main elements of which were introduced on 1 July 1998, has its genesis in the findings of the Financial System Inquiry (the Wallis Committee). The Inquiry recommended wide-ranging reforms to the structure of financial regulation, designed to achieve a more competitive, efficient and flexible financial system.

The regulatory framework consists of three agencies, each with specific functional
responsibilities:

• the Australian Prudential Regulation Authority (APRA), which has responsibility for prudential supervision;
• the Australian Securities and Investments Commission (ASIC), which has responsibility for market integrity and consumer protection across the financial system; and
• the Reserve Bank of Australia (RBA), which has responsibility for monetary policy and for overall financial system stability.

The Australian Prudential Regulation Authority is an integrated prudential regulator responsible for deposit-taking institutions (banks, building societies and credit unions) as well as friendly societies, life and general insurance and superannuation.^[1] APRA is charged with developing prudential policies that balance financial safety and efficiency, competition, contestability and competitive neutrality.

Deposit-taking institutions are now all regulated by APRA under the one licensing regime and are covered by the same depositor protection provisions of the Banking Act 1959. This legislation gives APRA the power to act decisively in the interests of depositors, including the power to revoke licences, to make prudential standards or issue enforceable directions, to appoint an investigator or statutory manager to an authorised deposit-taking institution (ADI) in difficulty or take control of the institution itself. If the difficulties prove intractable, 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, all ADIs are required to hold assets in Australia at least equal to their deposit liabilities in Australia. These arrangements, however, 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 in the case of ADIs, where the financial weakness of a life company, general insurer, friendly society or superannuation fund could have a detrimental effect on the interests of members and policyholders, APRA may intervene in the management of the troubled entity. 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 sets and enforces standards for financial market behaviour, for financial sector intermediaries, and for selling financial products, including investments, insurance, superannuation and deposit-taking activities (but not lending). These standards aim to protect markets and consumers from manipulation, deception and unfair practices and, more generally, to promote confident participation in the financial system by investors and consumers. ASIC also administers the Corporations Law with the aim of promoting honesty and fairness in companies and markets.

ASIC's submission to the inquiry by the Senate Select Committee on Superannuation and Financial Services into superannuation and financial services details the measures ASIC took to protect consumers in 1999. As part of its consumer protection role, ASIC also monitors and assesses compliance with 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. ASIC also supervises a number of industry-based alternative dispute resolution schemes and administers the consumer-related provisions of the Retirement Savings Account Act 1997.

The Reserve Bank of Australia has responsibility for monetary policy and for overall financial system stability. The RBA no longer has an obligation to protect the interests of bank depositors; rather, its task is to deal 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. If it were to provide such support, the RBA's preference would be to make funds available to the market as a whole through its domestic market operations. In certain circumstances, however, the RBA has said that it would be prepared to lend directly to a financial institution facing liquidity difficulties. The institution would have to be one supervised by APRA; would have to be solvent; and the failure to make its payments would have to pose a threat to overall financial system stability. APRA's judgments about the fundamental soundness of a financial institution in distress would be critical to any RBA support.

The RBA, under the auspices of its Payments System Board, also has a mandate to promote the safety and efficiency of the Australian payments system, and has the backing of strong regulatory powers. If the RBA, for example, assesses there is scope to improve access to, or the 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 Exchange Settlement Accounts for participants in the payments system and in 1999 it announced new arrangements which liberalised access to these Accounts.

Annual Reports and Internet sites of the individual Council members (see page 22) contain further details about their responsibilities and activities.

Developments in the Regulatory Framework

The final stage of the transition to the new regulatory framework was completed on 1 July 1999, with the transfer of responsibilities for institutions previously covered by the Financial Institutions (FI) Scheme to new national arrangements. The FI Scheme was a co-operative, uniform system of prudential supervision and regulation set up by the States and Territories in 1992, which governed the operation of building societies, credit unions and friendly societies. The Australian Financial Institutions Commission (AFIC) was the lead regulator of the FI Scheme, responsible amongst other things for the development of prudential standards, while day-to-day supervision and corporate regulation rested with State Supervisory Authorities.

Under the new arrangements, APRA assumed responsibility for the prudential supervision of the FI Scheme institutions, and ASIC for their corporate regulation. This transfer represented an historic example of the ceding of responsibility by the States and Territories to the Commonwealth in the interests of a more integrated and efficient system of protection for non-bank depositors and friendly society members.

The Council strongly supports APRA's current objective of developing a more integrated and harmonised supervisory framework for ADIs, to replace the previous disparate arrangements. The first stage in this project is the establishment of a single and 11 consistent set of prudential standards for ADIs to be issued under the Banking Act 1959. A number of draft standards have been released for industry comment and APRA expects to finalise the standards by mid 2000. Guidelines will also be issued setting out a uniform approach to the authorisation of ADIs. In the case of friendly societies, which are akin in important respects to life companies, APRA is working with the Life Insurance Actuarial Standards Board on the harmonisation of actuarial standards, which would apply to all life companies and friendly societies after a reasonable transition period.

Although the elements of Australia's financial regulatory framework are now all in place, the reform agenda promoted by the Financial System Inquiry has yet to run its full course. The Inquiry made a number of recommendations about the regulation of financial markets, which it found to be piecemeal and varied and subject to regulatory overlap. In particular, the Inquiry proposed that there be a single licensing regime for financial sales, advice and dealings in relation to financial products; consistent and comparable financial product disclosure; and a single authorisation procedure for financial exchanges and clearing and settlement facilities. The Government is responding to these recommendations in the context of its Corporate Law Economic Reform Program (CLERP).

The draft Financial Services Reform Bill, the outcome of the CLERP 6 consultation process, proposes a single statutory regime for the regulation of disclosure about financial products and services; for licensing and regulation of financial service intermediaries; and for licensing and regulation of financial markets and clearing and settlement facilities.^[2] The new legislation would replace much of the existing sector-specific and product-specific legislation, including legislation dealing with consumer protection in the superannuation and life and general insurance industries. The new regime will apply generally to financial products and services, and the differences of treatment now embodied in a variety of legislation will largely disappear.

The Government has announced it proposes to enact the legislation during 2000, with a view to its commencement on 1 January 2001.

This reform represents a major change in the regulatory framework administered by ASIC. One aspect of the reform also has implications for the role of the RBA. The legislation proposes that the licensing of clearing and settlement facilities should be by ‘the Minister’ (ie the Treasurer or a Minister in his portfolio) while regulation should be by ASIC, with a significant role for self-regulation. There is an important exception, however. In consultation with the RBA and ASIC, the Minister can declare that a particular clearing and settlement facility is of sufficient significance to the stability and integrity of the payments system that it should be regulated by the Payments System Board. This would have the effect of removing that facility from regulation under the new regime in the Corporations Law and placing it under a comparable regime to be Payment Systems (Regulation) Act 1998.

Once the legislation comes into effect, the RBA and ASIC intend to enter into a Memorandum of Understanding setting out areas of common interest as well as information-sharing and co-ordination arrangements.

Co-ordination between Council Members

Australia's financial regulatory structure includes strong mechanisms to ensure effective co-ordination and co-operation between the three regulatory agencies. These mechanisms 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 liaison framework, which is overseen by the Council itself, is a multi-tiered one. At the highest level is a structure of overlapping Board representation and regular senior meetings between the regulatory agencies. 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. In addition, the APRA Board meets formally with the ASIC Commissioners at least once a year, and senior APRA and ASIC representatives meet every six months to discuss matters of mutual interest.

At the operational level, co-operation arrangements have 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.

The Council is pleased that this liaison framework worked well in dealing with a number of issues during 1999. In the case of the RBA and APRA, for example, preparations for dealing with the Year 2000 problem called for continued close co-operation, which culminated in the establishment of a joint communications centre over the date change period (see Chapter 3). Another priority for these two agencies has been information sharing. The RBA is providing APRA with relevant data from the payments system and regular briefings on the Australian economy. In turn, APRA is supplying the Bank with data needed to construct the monetary and credit aggregates, as well as prudential data in aggregate form which are used to assess developments in the financial system. The RBA has also been working with APRA, and the Australian Bureau of Statistics (ABS), to produce comprehensive statistics on the foreign assets and liabilities of Australian financial institutions, as input into the International Banking Statistics compiled by the Bank for International Settlements.

On a broader front, APRA has embarked on a major project to develop an integrated statistics system and is working with the RBA and ABS to improve the comprehensiveness and consistency of financial data. When implemented, APRA will be the central repository of financial information on regulated entities collected by these agencies, to which the RBA and ABS will have secure access when needed. The RBA and ABS are also represented on the steering committee overseeing the project. In the longer term, it is proposed that a data management committee be established, with representatives including APRA, the RBA and ABS, to advise on and guide the development and maintenance of harmonised statistical collections. The project team is also discussing with ASIC its current and future requirements for access to data held by APRA, and the nature of arrangements to co-ordinate any ASIC-related data collections with those of the other agencies.

The RBA and APRA are also assessing the level of public disclosure by ADIs in areas such as the structure of capital, risk exposures and capital adequacy. One motivation for this is the current review of the 1988 Capital Accord being conducted by the Basel Committee on Banking Supervision. The Basel Committee has indicated its firm commitment to improving public disclosure and market discipline, particularly on the part of internationally active banks; in its view, effective public disclosure allows market participants to assess a bank's capital adequacy and can provide strong incentives to banks to conduct their business in a safe, sound and efficient manner. In Australia, where there is no deposit insurance scheme or deposit guarantee, it is especially important that the public have access to adequate financial information about ADIs so that they can make an informed judgment about the safety of their deposits.

APRA and ASIC both have close interests, particularly, in funds management and the two agencies work together to achieve compliance and enforcement in this area. Special focus groups meet on an ‘as required’ basis to discuss business and operational matters. For example, an Approved Trustee/Single Responsible Entity liaison group meets monthly; a policy focus group meets every six weeks; and the formal APRA/ASIC Co-ordination Committee meets quarterly to ensure close co-ordination of policy, operational and enforcement matters. This interaction is supplemented by various ongoing contacts between APRA's State Offices and ASIC's Regional Offices which are arranged locally by the relevant senior APRA executives and ASIC Regional Commissioners at their discretion. The agencies also conduct joint liaison with relevant industry bodies, including regular meetings with the Association of Superannuation Funds of Australia and the Investment and Financial Services Association.

In regulation, the two agencies have developed plans for joint inspection programs and for information sharing. In the managed investments area, they have worked together to minimise the risk of duplication of regulatory requirements. For example, they have established procedures for a ‘one-stop shop’ for applications from superannuation trustees seeking a licence as an approved trustee from APRA and a securities dealers licence from ASIC; they have also sought to align approval processes, including capital requirements, for custody activity in the superannuation and managed investments area.

In enforcement, APRA and ASIC have co-operated closely on a number of matters, including by short-term placements of staff to work on joint APRA-ASIC enforcement task forces. A national enforcement focus group, which meets every two months, ensures an appropriate overall strategy, effective communication on major enforcement cases and information sharing about operational matters involving both agencies.