Treasury's Exposure Draft Bills introduce important and significant changes

By Michelle Levy, Michael Mathieson
APRA ASIC Financial Services

In brief 12 min read

On Friday the Government released a rather large package of Exposure Draft Bills to implement the last of the Financial Services Royal Commission recommendations, just in time for the first Unravelled for 2020.

There are some important and significant changes and Treasury is consulting widely (although not for very long) and seeking feedback. In a rather nice, if curious, touch the Explanatory Memorandum to the Bill that will turn a 'superannuation trustee service' into a new financial service concludes with: 'We welcome comments from stakeholders on whether this relief is required, and if so, what the scope of the relief should be'.

The Bills cover a lot of territory.

A new supervisor for ASIC and APRA

One Bill will establish the new Financial Regulator Assessment Authority. The Authority will be required to decide every two years whether APRA and ASIC are effective and, on request from the Minister (but at least every four years), whether they are capable. The Authority will only have four part-time members and, it seems, a pretty lean staff, so it is most likely these reviews will be another job for the consulting firms (we chose the wrong profession).

Bibs and bobs

The Bills will also introduce deferred sale requirements for 'add on insurance', provide ASIC with the power to impose caps on commissions paid to car dealers for selling add on insurance, amend the duty of disclosure for insureds (to reduce the rights of insurers) and insurers and make it unlawful for a person to call something insurance when it is not, or to describe themselves as an insurer if they are not (you might think there is already a law against both).

They will also expand the anti-hawking provisions to prohibit the unsolicited selling of financial products (we wish you luck in figuring out whether a given situation involves ‘unsolicited contact’ or not), require AFS licensees and Australian credit licensees to check references for financial advisers and mortgage brokers, create additional obligations for superannuation trustees paying advice fees (ongoing and otherwise) and give ASIC a broad directions-making power. Given its breadth, we are left wondering why ASIC needed the product intervention power that accompanied the Design and Distribution Obligations Bill.

Superannuation will not be for the faint hearted

The Bills will bring superannuation completely into the world of Chapter 7 of the Corporations Act by creating a new financial service - 'superannuation trustee service'. The definition is a little odd - a person will be taken to provide a superannuation trustee service if 'they operate a registrable superannuation entity as trustee of the entity'. It begs the question as to whether someone other than the trustee can operate a superannuation fund and, conversely, whether it is possible for the trustee not to do so. Could a trustee for hire say that they do not operate a fund?

Leaving these questions aside, it seems pretty clear that this Bill will stop lawyers like us saying that an RSE licensee is not required to comply with its AFS licensee duties, including the duty to act efficiently, honestly and fairly, except in relation to a limited range of activities (issuing interests in the fund and providing financial product advice). This change might seem perfectly reasonable, except when one looks at all the overlapping but differently formulated obligations that will apply to the trustee of a superannuation fund that has to comply with an ever-expanding and increasingly prescriptive collection of covenants (which are duties owed to and enforceable by members against the trustee and its directors) and the prudential standards. The former can also now lead to civil and criminal penalties.

In making a decision about changes to product terms, superannuation trustees will need to consider whether they are acting in the best interests of members, promoting their financial interests, acting fairly, acting efficiently, acting honestly and also turn their minds (under the Design and Distribution Obligations) to whether the product is suitable for the class of person to whom it will be offered. Trustees with existing AFS licences will automatically be issued with an authorisation to provide a superannuation trustee service from 1 July 2020. That much will be welcome.

The Bills will also amend the law so that RSE licensees cannot assume an obligation to act in the interests of anyone other than the beneficiaries of an RSE or the recipient of personal advice. The activities that will and won’t be affected by the amendment are hard to rationalise. A superannuation trustee will not be able to be an IDPS operator but will be able to provide platform services (both super and non-super) to other platform operators. The exception for personal advice is very odd – it is apparently there so a superannuation trustee can provide comprehensive personal advice, including advice on matters other than the member’s interest in the fund (notwithstanding the associated sole purpose test issues). Why a superannuation trustee should be free to provide personal advice on an IDPS account, but not provide the IDPS account itself, is far from clear to us. It appears that transitional relief will be provided by APRA on a case by case basis.

Treasury has also not missed the fact that the current limitations on the trustee's right of indemnity in relation to civil penalties only apply to penalties under the SIS Act. This exclusion will be expanded so that it applies to a penalty under any Commonwealth Act. While this makes sense, it just makes the question as to how a trustee without any capital will be able to pay a civil penalty (or criminal for that matter) more pointed. In a limited acknowledgment of this issue, the amending legislation includes provisions requiring a court to take into account the likely impact (on fund beneficiaries) of the imposition of a fine on the trustee.

It is fair to say that being a superannuation trustee (or a director of one) will not be for the faint hearted.

Breach reporting will be more stringent and more wide-ranging

The Financial Sector Reform (Hayne Royal Commission Response – Protecting Consumers (2020 Measures)) Bill 2020: FSRC rec 1.6, 2.7, 2.8, 2.9 and 7.2 (Reference checking and information sharing, breach reporting and remediation) will replace the existing breach reporting obligations in the Corporations Act. The new reporting obligations will also be inserted into the National Consumer Credit Protection Act and apply to Australian credit licensees in the same way and largely in the same terms as to AFS licensees. But for now we have just discussed the Corporations Act provisions.

We have set out the full name of the Bill, not only because it is slightly amusing, but also to give you a flavour of what is covered, including to point out that the law will impose 'remediation' obligations. We don't know when remediation became a word (Michelle's admittedly rather old dictionaries do not include it, nor do Michael’s slightly less old dictionaries) and yes, we know that English is a living language, but nevertheless we are suspicious of it. Not only because we do not really know what it means, but also because it is frequently used to refer to some rather vague undertakings to maybe fix, or undo, or make good some errors or breaches in some rather unclear ways. Happily the Bill does not use the term in its operative provisions. Instead it talks about loss or damage to the client and paying the client an amount equal to the loss or damage within 30 days of the completion of an investigation. But more of this later.

Under the new provisions, AFS licensees will be required to provide a report to ASIC if there are 'reasonable grounds to believe' that a 'reportable situation' has arisen. One might infer that ASIC is somewhat exasperated by unclear or evasive breach reports because there is also a new obligation to report in the prescribed form. Presumably, the prescribed form will require licensees to identify the legal obligations to which the report relates.

There will be a reportable situation if either the licensee or its representative has breached a 'core obligation' or is likely to do so, or if the licensee has commenced an investigation into whether the licensee or its representative has breached a core obligation (at some point there will, inevitably, be a lively debate about whether an activity amounting to ‘an investigation’ of the relevant kind ‘has commenced’). In each case the breach or likely breach must be significant. The obligation to report a representative's breach will no longer turn on whether the licensee has also breached its own obligation. And there is more. As the Bill says: 'There is also a reportable situation if the licensee or its representative has been grossly negligent or committed a serious fraud'.

The core obligations are pretty much the same as the obligations for which the significant breach reporting obligation applies now – a breach of the obligation to act efficiently, honestly and fairly, a breach of AFS licence conditions and a breach of the prescribed financial services laws (Chapter 7, the ASIC Act and so on) and a breach of the prescribed Commonwealth legislation (the SIS Act and others). Remember that, for RSE licensees, operating a superannuation fund 'as the trustee' will be a financial service.

Failing to report may lead to some pretty stiff penalties, including a spell in gaol. The reporting obligations will also be infringement provisions, meaning ASIC will be able to issue a fine if it suspects (it doesn't have to prove) a licensee has breached its reporting obligation. On this power the draft Explanatory Memorandum says: 'The use of an infringement notice is appropriate as it is expected that there will be a high volume of contraventions of the reporting provisions'.

It is not clear why it is expected – is it an acknowledgment that the obligations of an AFS licensee are so broad and so onerous that they couldn't really be expected to identify all reportable matters? We worry that this will in fact be the case and we think that that is an extremely poor outcome. Licensees shouldn't have to rely on an exercise of discretion by ASIC in determining the penalty for a breach (or ASIC's belief that there is a breach) of its reporting obligations, especially where the breach is based on a legitimately held opinion by the licensee that a matter wasn't reportable. Despite the intention to create greater certainty and less subjectivity, in very many cases identifying a breach is not black and white.

A breach will be taken to be significant and reportable if it is punishable on conviction by imprisonment in excess of the prescribed terms, the breach is a breach of a civil penalty provision, the breach results in or is likely to result in loss or damage to clients or it is a prescribed matter. These reportable breaches will be in addition to the obligation to report breaches that the licensee considers significant having regard to the current matters about number and frequency, harm and so on.

There are also some dobbing obligations – licensees must report on other licensees where there are reasonable grounds to suspect a reportable situation has arisen in relation to that licensees and an individual representative of the licensee where the representative provides personal advice (or under the NCCP, where the representative is a mortgage broker). Licensees must also notify clients of the adviser or mortgage broker where there are reasonable grounds to believe they have or will suffer loss or damage as a result of the reportable situation and the client has an enforceable right to recover the loss or damage and, as we also noted above, to compensate the client for the loss or damage. The same obligations apply to the credit licensee in relation to loss or damage to a client of a mortgage broker.

We think these provisions requiring notice to affected clients and compensation are surprising. Given the many important matters that are left for regulations and legislative instruments (eg we are thinking here of bans on conflicted remuneration), we query why these requirements do not fall into the same category, especially given ASIC seems to be dealing with them pretty effectively now on a case by case basis with individual licensees. If it was worried about its power to do so, the directions-making power in these Bills will deal nicely with that.

If a report is required to be provided, it must be provided within 30 days (this is a bit more comfortable than the current 10 business days) after the licensee 'first reasonably knows that there are reasonable grounds to believe the reportable situation has arisen'. The Bill tells us when a person 'reasonably knows' something and, consistent with the efforts to introduce an objective standard, a person may not in fact know something they are taken to 'reasonably know'.

And why we say this is ironic

There is so much more to say about lots of this and we will keep on doing so over the next six months (most of this is due to start on 1 July 2020), but in the meantime we would like to leave you with two thoughts.

One of Commissioner Hayne's main messages was that a financial services provider's obligations were underpinned by some pretty clear and straightforward legal obligations which are already contained in the law. Commissioner Hayne was also critical of complexity and exceptions. One of his messages for financial services providers was that they should be simplifying their businesses. Well this package of Bills will not help, except to the extent that it might in fact prompt some providers to bring in their shingles permanently.

This legislation gives more power to the regulators, chiefly ASIC, not only to enforce the law, but to make the law. This of course is not new, but the expansion and importance of regulator-made law is very concerning, particularly when matched with stronger enforcement powers and some very serious penalties, including imprisonment.

Apart from a philosophical objection to the law being made by public servants, the quality of that law is particularly troubling. APRA's prudential standards are an excellent example of the problem. They are written in a discursive style with lots of obligations to take steps to do things, to put in place systems and to adopt policies. These sorts of obligations are not well suited to breach reporting and enforcement and so much appears to be acknowledged in the Bill that will give ASIC power to make the provisions of an industry code enforceable. A condition to exercising that power is that the term of the code is 'legally effective' and 'capable of being enforced'. We think it would be a good thing if the same rules were applied to regulator-made law so that it is clear when a particular obligation has been breached. This will matter so much more with the new reporting obligations.

We look forward to discussing this with you.

Michelle Levy and Michael Mathieson