Banking - wholesale
Much will be familiar to banks, including their investment banking and broking arms, that are engaged with wholesale and institutional clients. Regulation in many respects has become more coherent and clearer under the FSR regime. Nevertheless, many concepts introduced by FSR still have to be mastered by the banking industry.
See also - retail banking
Updated as at 11 March 2004.
What does FSR mean for wholesale and institutional banking?
Financial products
This very broadly drafted functional definition covers many things typically within the product ranges of banks. Important exclusions are the provision of loans or credit facilities, the physical delivery of cash and foreign exchange contracts that are not derivatives and are settled immediately with physical cash. Foreign exchange transactions not settled immediately and therefore with some risk are caught as financial products. The concept of financial products also covers, amongst many other things, a more limited definition of securities, a wide definition of derivatives and interests in managed investment schemes.
Financial markets
These are like the pre-FSR stock markets and futures markets but cover all financial products. 'Facilities' are very popular with the draftsman; both a financial product and such a market can involve a 'facility' (although it is only defined for the former) and the idea seems to be to catch every means of creating a product and a market. It excludes, amongst other things, facilities where only one person makes or accepts offers for financial products on its own behalf, or on behalf of one party to the transaction only (intended to exclude direct, negotiated bilateral transactions with counterparty risk on each side - for example most OTC derivatives transactions) and importantly also products supported by single institutions.
Banks are in the vanguard in using e-commerce's potential with wholesale clients and care is required that some trading platforms don't fall within this category. The ease with which markets can be created electronically has ASIC alert to regulatory implications although they have announced they will interpret the broad definitions so that only activities that compromise the regulatory outcomes are caught. Pure market making activities are not caught (although market makers are within the ambit of financial services and information providers may be if giving advice).
For a facility to be a financial market it must provide for multilateral participants in buy or sell or other offer or acceptance transactions for financial products through the facility. Market participants should note the 15% voting power limit that may be placed on persons who hold interests in entities that are the subject of a declaration by the regulators and that have an Australian market licence or an Australian CS (Clearing and Settlement) facility licence.
Bilateral trading arrangements are not caught here but rather under financial services regulation.
Financial services
If not usually operating a financial market a bank will usually be providing a financial service, in a financial services business. Holders of licences from the Australian Prudential Regulation Authority (APRA) are still required to be licensed under FSR. In that case, ASIC must consult with APRA.
The legislation and commentary makes it clear that OTC derivatives markets are meant to be regulated through the licensing of financial services businesses, not as financial markets. However, the undefined concept of 'facility' within the financial market definition may theoretically catch some potential OTC trading arrangements and markets given the tremendous linkages created by e-commerce. Care and monitoring is required in this area.
Disclosure
Point of sale disclosure for all financial products is covered by the same regime (other than in the case of the issue and sale of securities which have their own regime). Wholesale clients only have the benefit of general protections against misleading and deceptive conduct and the like and unconscionable dealing, although a licence duty on the provider of financial services to provide them in a 'fair' way to all clients, now applies. In the case of most, if not all, wholesale clients this is inappropriate.
Securities and derivatives
The definition of 'securities' for fund raising purposes and for the FSR licensing regimes and many aspects of financial services and markets covers shares and debentures and certain interests in them. With one exception (see below), it excludes interests in managed investment schemes and does not include options over already issued securities (unlike the pre-FSR regime), only options to acquire unissued securities. The definition of securities for these purposes thus seems to be confined to purely capital raising devices. However, for title and transfer purposes it includes managed investment products.
The meaning of securities for takeovers, some market information purposes and continuous disclosure is largely the same as the pre-FSR situation, except that it also, as expected, includes registered management investment schemes.
The concept of 'derivatives' introduced by FSR covers familiar ground such as futures contracts but extends to a wide range of other exchange and OTC derivatives. It includes warrants (that were securities under the pre-FSR framework) and exchange traded options over existing securities but not, as already indicated above, bilateral options over unissued shares. As indicated above, 'spot' foreign exchange is caught as a financial product. Other financial products whose value, or the consideration to be provided by one party, varies by reference to something else, are also derivatives but foreign exchange contracts not settled immediately or within not less than three days are not derivatives.
A threshold or a face or notional amount of A$500,000 is required to make a derivative a wholesale client transaction. A similar limit applies for foreign exchange financial products by reference to the amount of consideration.
The definition of security takes precedence over the definition of derivative which means that a hybrid security and derivative product will be a security.
(Many regulatory uncertainties with the pre-FSR securities and futures distinctions have been cleared up as a result of FSR.)
Insider trading
The rules governing insider trading cover not only securities, but also all derivatives and managed investment products, superannuation, and all other financial products able to be traded on a financial market. (The Federal Treasury subsequently introduced further regulatory change to allay market concerns as to the application of the insider trading provisions to OTC derivatives.)
What do I need to do?
If you are propose to provide financial services within Australia you must:
- become familiar with the concepts of financial products, markets and services;
- consider their application to your planned business;
- understand the compliance and prudential requirements likely to apply to your business; and
- obtain the licences required for you lawfully to conduct your business.
What should I continue to do?
The two-year grace period for FSR ended on 10 March 2004. So, it is imperative that you continue to:
- assess what categories your businesses and products, particularly new business and services, fall into;
- review new documentation, marketing and advertising material;
- ensure you maintain an up-to-date training register and sufficient organisational expertise;
- audit business practices, particularly the giving of financial product advice, to ensure proper compliance; and
- keep abreast of market practice, ASIC policy and developments in the law applicable to your organisation.
There is still much to learn and to do.
Who should I contact at Allens?
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