Council of Financial Regulators Annual Report – 2000 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, arose out of 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.^[2] APRA is charged with developing prudential policies that balance financial safety and

Deposit-taking institutions are now all regulated by APRA under the one licensing regime and are covered by the same ‘depositor preference’ 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

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 or the Government.

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 compensate members of a fund for losses due to fraud, either from Consolidated Revenue or by levying other funds within the industry, where such compensation is judged to be in the public interest. Again, however, members' and policyholders' entitlements are not guaranteed by either APRA or the Government.

The Australian Securities and Investments Commission administers and enforces a range of legislative provisions relating to financial markets, financial sector intermediaries and financial products, including investments, insurance, superannuation and deposit-taking activities (but not lending). ASIC's aim is 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. With this in mind, ASIC also seeks to promote honesty and fairness in company affairs and securities and futures markets through adequate and timely disclosure of market information. ASIC also:

• develops policy and guidance about the laws which it administers;
• licenses and monitors compliance by participants in the financial system; and
• provides comprehensive and accurate information on companies and corporate activity.

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.

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 that have the potential to spill over to economic activity and consumer and investor confidence. In the event of such threats, the RBA retains its discretionary role of ‘lender of last resort’ for emergency liquidity support. 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 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 that liberalised access to these Accounts.

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

Developments in the Regulatory Framework

Since its establishment, APRA has given priority to developing a more integrated and harmonised supervisory framework for ADIs, to replace the previous disparate arrangements. Following the release of draft prudential standards and a process of industry consultation, APRA released a set of harmonised prudential standards for all ADIs in September 2000. The standards and associated guidance notes cover capital, liquidity, credit quality, large exposures, equity associations and audit arrangements.

In addition, APRA has introduced a comprehensive framework for the prudential supervision of conglomerate groups that include an ADI. The framework, set out in a Policy Information Paper released in April 2000, provides for an expansion of the range of organisational structures that conglomerates may adopt and for a liberalisation of the activities that can be carried out by a conglomerate group containing an ADI. Within this framework, APRA will give increased attention to group-wide risk management practices in conglomerates containing an ADI.

APRA has also undertaken a significant overhaul of the prudential framework for the general insurance industry, which has been little changed since the Insurance Act 1973 was introduced. After a first formal round of consultations in the latter part of 1999, APRA published a Policy Discussion Paper in April 2000 setting out its proposed reforms to the prudential supervision of general insurance companies, and followed this by the successive release of a number of draft prudential standards. The consultation process is scheduled for completion around the middle of 2001, and is complemented by proposed amendments to the Insurance Act 1973 to give effect to the new standards from 1 July, 2002.

The remaining plank of the reform agenda promoted by the Financial System Inquiry deals with the regulation of financial markets, which the Inquiry found to be piecemeal and varied and subject to regulatory overlap. The Inquiry recommended 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 has responded to these recommendations in the context of the sixth stage of its Corporate Law Economic Reform Program (CLERP 6).

The outcome of the CLERP 6 consultation process has been the Financial Services Reform Bill, which was introduced into Parliament in April 2001 after delays attributable to legal complexities with the Corporations Law. The Corporations Law operated through an agreement between the Commonwealth and the States under which a uniform Federal system of law was applied via State legislation. A series of High Court judgments, however, had cast doubt on the validity of these arrangements. To overcome this problem, the States have agreed to refer their powers in relation to corporate law to the Commonwealth, enabling a constitutionally valid national scheme for corporate law to be introduced. These new arrangements, which will underpin the Financial Services Reform Bill, are intended to commence in July 2001.

The Bill itself introduces a streamlined regulatory regime for market integrity and consumer protection across the financial services industry. It provides for a harmonised licensing, disclosure and conduct framework for financial service providers, and a single statutory regime for financial product disclosure, replacing much of the sector-specific and product-specific legislation. At the same time, the framework allows for flexible treatment of different financial products where appropriate (eg basic deposit products will be subject to less intensive regulation than more complex investment products).

The multiple routes to licensing of securities and futures exchanges, and clearing and settlement systems, will be replaced by a single licensing regime for an Australian financial market and for a clearing and settlement facility. Under the new arrangements, licensees will have primary responsibility for the operation of markets and of clearing and settlement facilities; ‘the Minister’ (ie the Treasurer or a Minister in his portfolio) will have overall responsibility for licensing such entities. ASIC will be empowered to advise the Minister on licensing matters and will also be required to undertake assessments of the compliance of market and facility licensees with their legislative obligations. The RBA is also intended to have a role in the regulation of clearing and settlement facilities in relation to systemic risk matters, given the importance of such facilities to the overall stability of the financial system.

The Government expects the Financial Services Reform Bill to come into effect on 1 October 2001. Once the legislation is enacted, ASIC and the RBA will 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 epresentatives 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.

This liaison framework received a thorough testing in dealing with the Year 2000 problem. While the date change passed virtually without incident, planning for Year 2000 contingencies demonstrated the capacity of the regulatory authorities to work closely together, in co-ordinating their involvement with financial industry groups, promoting disclosure of Year 2000 preparations and operating a joint communications centre over the date change period.

On a more routine basis, the RBA and APRA now have well-established arrangements for sharing information relevant to each agency's responsibilities. The RBA provides APRA with briefings on the Australian economy and relevant data from the payments system. In turn, APRA supplies the Bank with data needed to construct the monetary and credit aggregates, as well as aggregate prudential data which are used to assess developments in the financial system. During the year, the two agencies in conjunction with the Australian Bureau of Statistics (ABS) finalised 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. Australia was included in this collection from August 2000.

APRA is undertaking 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, 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 continued work on assessing the level of public disclosure by ADIs. During 2000, the two agencies conducted a survey of public disclosure in areas such as the structure of capital, risk exposures and capital adequacy. One motivation for this is the review of the 1988 Capital Accord by the Basel Committee on Banking Supervision.^[3] ‘Pillar 3’ of the New Basel Capital Accord emphasises the role of effective public disclosure in enhancing market discipline; in the Basel Committee's view, such disclosure is an important ally of the supervisor as it allows market participants to assess a bank's capital adequacy and can provide strong incentives to banks to conduct their businesses in a prudent manner.

The year 2000 also saw an enhanced level of co-operation between APRA and ASIC, particularly in funds management, which is a key area of common interest. There is regular (monthly) liaison between APRA and ASIC's Managed Investments National Team, focussing on issues relating to the licensing of superannuation and funds management entities regulated by both agencies. On an operational level, liaison groups cover areas of mutual interest such as enforcement and the regulation of superannuation. In addition to this formal liaison structure, ad hoc co-operation between the agencies has intensified, including the provision of technical assistance in litigation matters, joint responses to requests from international regulators and co-ordination of liaison with industry bodies.

As required, regular liaison meetings are held between APRA and ASIC on specific enforcement-related matters. The two agencies have commenced a review of processes to clarify the actions required prior to the formal referral of enforcement matters to each other, as well as post-referral liaison. An enforcement workshop involving both APRA and ASIC staff was held in August 2000 to promote better understanding of responsibilities and the sharing of information.

The two agencies also seek to co-ordinate ASIC's actions on consumer protection issues, such as disclosure and complaints handling, with APRA's prudential supervision of the financial institutions concerned. This is facilitated through ongoing liaison between APRA and ASIC's regional offices, which also have regular contact on emerging issues as well as specific institutions. Some joint reviews of institutions have been carried out and all liaison groups will continue to identify situations where such reviews can be useful.

In recognition of the growing importance of e-commerce activities by financial institutions, APRA, ASIC and the Australian Competition and Consumer Commission (ACCC) established a group to share information on current and emerging issues in this area. APRA, ASIC and the RBA have also established a group to share information on, and assess the implications of, account aggregation services over the Internet.