## _cr06415 ## Source details **Canonical URL:** [_cr06415](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06415.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06415.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06415.pdf.json) --- ### General assessment, methodology, and scope - Assessment completed as part of a Financial Sector Assessment Program undertaken in December 2005 by the International Monetary Fund. - Review covers legal framework and detailed examination of policies and practices of institutions responsible for banking, insurance, securities and payments supervision. - Assessment team: Michael Andrews (IMF-MFD Consultant) and Göran Lind (Sveriges Riksbank). - Qualitative four-part assessment system used: compliant; largely compliant; materially non-compliant; non-compliant. - Sources reviewed: laws, prudential standards, supervisory practice, on-site and off-site supervision, industry data, and comprehensive self-assessments by Australian authorities. ### Preconditions and macro-financial context - Structural and macro outcomes: - Economic expansion began in 1992 and, at time of assessment, was in its fourteenth year. - Unemployment rate has fallen by 6 percentage points since 1992. - Inflation remained low and net public debt was nearly eliminated. - Financial system size and composition (exact figures preserved): - Financial system assets amount to over 300 percent of GDP. - Authorized deposit-taking institutions (ADIs) account for about half of total financial system assets. - A further 23 percent of assets are held by life insurers and superannuation funds. - Stock market capitalization is over 100 percent of GDP. ### Institutional framework and responsibilities - Functional allocation of roles: - APRA: prudential supervision of banks, insurers and superannuation funds. - ASIC: market conduct regulator and administrator of company law for listed and unlisted companies (AFSL regime). - RBA: payment system oversight and overall financial stability; operator and overseer of RITS. - AUSTRAC: federal financial intelligence unit (FIU) and AML/CFT regulator. - Treasury: legislative preparation and policy advice to the Treasurer; Treasurer may issue directions to APRA and ASIC. - Attorney-General’s Department: AML/CFT laws and policy advice to the Minister for Justice and Customs. - APRA specifics: - Established under Australian Prudential Regulation Authority Act 1998; powers in section 11. - Staff: 612 (covering ADIs, insurance and superannuation supervision). - Staff turnover: some 20 percent per year (identified as a concern). - APRA financing: levies on supervised entities; levies determined/collected by government and allocated to APRA. - Legal protection: Sec 58(1) APRA Act limits liability except for bad faith; APRA assists staff in defense and has Deed of Indemnity arrangements for Members. - ASIC specifics: - Mandate under Section 1(2) of the ASIC Act to “strive to maintain, facilitate and improve the performance of the financial system…promote the confident and informed participation of investors.” - Funding: government budget; recent increases including the 2006–07 Budget (additional funding referenced under Introduction). - Staff retention improved from >20% to around 12%. - ASIC cannot issue legally enforceable rules; Minister issues regulations; ASIC can grant exemptive relief and publish Policy Statements. Banking sector — key structure and statistics - ADI population: 238 ADIs, including: - 14 Australian-owned banks - 11 foreign subsidiary banks - 28 branches of foreign banks - 14 building societies - 158 credit unions - 3 specialist credit card institutions - 3 ADIs that provide services to member building societies and credit unions - Market concentration: - Largest five banks held some 74 percent of assets. - Credit unions and building societies total assets comprise less than 2 percent of total ADI assets. Major findings — banking supervision (Basel Core Principles) - Overall compliance: Australia assessed as having a high level of compliance with the Core Principles essential and additional criteria; specific leading-edge areas noted: capital adequacy and risk-based supervision. - Principle 1 (Objectives, autonomy, powers, resources) — Assessment: Compliant. - Five of six subcomponents fully complied with; CP 1(6) (information sharing/confidentiality) assessed “largely compliant”. - Recommendation: Formal legal requirement to publicly disclose reasons for removing an APRA Member from office recommended; APRA should have written policies on legal assistance/indemnity for Members and staff. - Principle 2 (Permissible activities) — Assessment: Largely compliant. - Sec 5 BA defines “banking business”; Sec 11 exemptions permit wholesale exemptions; assessors recommended reviewing Sec 11 exemption policy to ensure significant deposit-takers are within prudential framework. - Principle 3 (Licensing) — Assessment: Compliant. - BA requires banks to have at least $A 50 million in Tier 1 capital to use the word "bank"; APS and application requirements include 3-year business plans with scenario projections. - Principle 6 (Capital adequacy) — Assessment: Compliant. Key numeric standards: - Statutory requirement: 8 percent total risk-weighted capital, of which 4 percent must be tier 1 capital (s7 APS 110). - Typical APRA-assessed required ratios often between 10 and 20 percent depending on risk profile. - Institutions using the word "bank": at least $A 50 million in tier 1 capital; building societies: at least $A 10 million in tier 1 capital. - ADIs required to calculate their own "economic capital". - Principle 9 (Large exposures) — Assessment: Compliant. Prudential limits (paragraph 9 APS 221): - 25 percent of capital for non-government, non-bank, unrelated parties; - 50 percent of capital for unrelated banks; - 50 percent of capital for foreign parents and their subsidiaries, with aggregate exposure to non-deposit-taking subsidiaries capped at 25 percent of capital. - “Large exposure” defined as 10 percent of capital for reporting. - Principle 10 (Connected lending) — Assessment: Compliant. - APS 222 reporting and limits; example limits preserved verbatim: related non-bank regulated entities more lenient (35 percent of level 1 capital) than unrelated non-bank entities (25 percent of capital); individual related unregulated entities limited to 15 percent of level 1 capital; related ADI exposure examples include 50 percent of level 1 capital etc. - Recommendation: Expand definition of related parties to explicitly include individuals (officers, directors, persons related to or closely associated with such persons). - Supervisory approach: - APRA uses PAIRS (Probability and Impact Rating System) and SOARS (translates PAIRS into supervisory stance) to prioritize supervision and determine supervisory stances: Normal; Oversight; Mandated Improvement; or Restructure. - APRA Supervision Framework supported by Activity and Issue Management System (AIMS). - Assessment: On-site and off-site supervision — Compliant; some variation in report quality due to staff turnover; recommendation to standardize off-site analysis for consistency. - Remedial powers and failure management: - APRA’s powers escalate: preventative, corrective, failure management; Sec 11CA BA grants wide powers of direction; Sec 13A/13C BA for appointment of investigators/administrators/statutory managers. - RBA as lender-of-last-resort: will consider lending only if failure is systemic; will not lend to insolvent institution. - Government deposit guarantee: no explicit depositor guarantee decided; depositor preference exists in ADIs in liquidation; historical government interventions have created impression of an implicit government guarantee. - Assessment: Remedial measures — Compliant. - Comment: Consideration given to possible introduction of merits review for APRA decisions but caution to avoid impeding timely crisis action. AML/CFT and Core Principle 15 (Use of banks by criminal elements) - Principal finding: Materially non-compliant for CP 15. - Key shortcomings: - Absence of an effective regime of on-site verification by AUSTRAC; many essential criteria for CP 15 require on-site verification. - AUSTRAC empowered to conduct on-site verification but historically focused on education and conducted only two compliance examinations of banks in the prior two years. - AUSTRAC currently unable to share suspicious transaction information with APRA; APRA can disclose to AUSTRAC but not vice versa — legal obstacle. - No statutory requirement for banks to appoint a senior officer with explicit AML/CFT compliance responsibility; AUSTRAC only recommends such appointment. - APRA Supervision Modules contain no specific references regarding suspicious transaction reporting systems. - Required verification items (preserved list of items assessors noted): - Banks’ policies and procedures for high ethical standards and prevention of use by criminal elements (EC 1); - Documented and enforced procedures for identification of customers (EC 2); - Formal procedures to recognize potentially suspicious transactions (EC 3); - Banks’ appointment of a senior officer to ensure compliance with statutory requirements (EC 4); - Banks’ procedures clearly communicated to all staff for the reporting of suspicious transactions (EC 5); - Banks have established lines of communication to management/internal security for reporting problems (EC 6); - Banks’ internal processes and controls for anti-money laundering are sufficient (EC 9). - Planned remedial actions and timelines: - AUSTRAC expected to build capacity over a two year period for on-site verification. - Government committed to update AML/CFT regime; legislation expected to be introduced during 2006 to allow AUSTRAC to share FTR information with APRA and include APRA as a partner agency. - Recommended action (from Action Plan excerpt): - Remove legal obstacles to AUSTRAC sharing information with APRA and implement effective coordination regarding information gathered by AUSTRAC relevant to APRA’s prudential oversight. Insurance sector — IAIS ICP assessment (selected findings) - Scope: Assessment against IAIS ICPs (October 2003 methodology); life and general industries assessed separately where applicable. - Conditions for effective insurance supervision — Assessment: Observed. - IFRS adoption from 1 January 2005; auditing standards established by AUASB; approximately 6,110 registered auditors. - Supervisory authority and powers: - APRA responsible for insurance prudential supervision; some powers require Treasurer’s agreement in specific areas. - Assessment: Supervisory authority — Largely observed (APRA powers broad; some Treasurer involvement noted). - Licensing and market structure: - Insurers require APRA authorization and AFSL from ASIC (insurers must hold two licenses). - DOFIs and DMFs accounted for 0.5 percent of the Australian insurance market (industry-provided data to the Potts Review); DOFIs not prudentially supervised by APRA and must hold an AFSL and disclose non-APRA authorization. - Government agreed to Potts Review recommendation that DMFs offer cover only as a contract of insurance under the IA unless APRA considers no contingent risk. - Fit and proper and governance: - APRA released new harmonized 'fit and proper' prudential standards on 2 March 2006. - Governance standards (new APRA prudential standards released 5 May 2006) cover board composition, mandatory audit committee, internal audit, auditor independence, board renewal and performance assessment. - Assessment: ICP 7 Suitability — Observed (life) and Partly Observed (general) prior to March 2006; with March 2006 standards both regimes fully observe ICP 7. - Capital adequacy and solvency (detailed numeric and policy statements preserved): - General insurance: GPS 110 sets MCR; policy intention MCR sufficiency level of 99.5%; minimum MCR coverage is 1.2 times; MER for catastrophic losses required; Tier 1/core capital must be at least 50 percent of capital base; foreign branches must maintain assets in Australia at least equal to the MCR. - Life insurance: solvency designed at a safety level of 99.5 percent; capital adequacy target policy intention of 99.75 percent; actuarial standards (AS 1.03, 2.03, 3.03, 6.02) define valuation and management capital; management capital minimums include a new business reserve and minimum A$10 m outside statutory funds. - Assessment: Capital regimes — Observed (general and life); APRA plans harmonization with bank/regulator regimes. - Market conduct, consumer protection and intermediaries: - AFSL regime enforced by ASIC; client money held in trust; disclosures (FSG, SOA, PDS) required; external dispute resolution schemes mandated. - Assessment: Consumer protection and intermediaries — Observed. - AML/CFT for insurers (ICP28): - FTR Act imposes reporting, customer due diligence and recordkeeping on cash dealers (includes insurers); AUSTRAC supervises FTR Act obligations but cannot currently share suspicious transaction information with APRA. - FATF October 2005 Mutual Evaluation Report found shortcomings and implementation not effective against revised 40 Recommendations. - Assessment: Partly observed. - Key recommended insurer actions (selected): - Implement Potts Review recommendations on DOFIs and DMFs appropriately. - Grant APRA explicit powers for cross-border supervision of insurers’ overseas subsidiaries. - Empower APRA to deal with troubled institutions in a timely and cost-effective manner; consider harmonizing powers across banking, life and general insurance. Securities regulation — ASIC and IOSCO principles (selected findings) - Market scale and activity: - Australia ranks globally as the seventh biggest foreign exchange market; $US/$AUS is the fourth most-traded currency pair; Australian dollar is the sixth most-traded currency; stock market rated eighth largest. - ASX average daily equities turnover: some $A 3.2 billion during 2004–05; 78 percent from institutional investors. - Total domestic capitalization of 1,774 companies: $A 975 billion at end-June 2005. - ASIC institutional findings: - Implementation status summary (from Table 8): - Implemented: 21 principles - Broadly implemented: 5 principles - Partly implemented: 2 principles - Not implemented: 1 principle (Principle 8 — inspection, investigation and surveillance powers in relation to AML/CFT gaps) - Operational independence and accountability: considered “broadly implemented”; Minister may issue written directions (used only once in 1992); Minister may direct ASIC to investigate; ASIC subject to judicial review and AAT merits review. - Funding and staffing: 2006–07 Budget increased ASIC funding by approximately 25 percent (additional $234.6 million over four years — stated in Introduction context); reliance on government funding poses budget vulnerability risks. - Enforcement and powers: - ASIC has broad civil and criminal enforcement powers; can issue enforceable undertakings and infringement notices for continuous disclosure breaches; capability to seek criminal prosecutions via CDPP. - Gaps noted: lack of comprehensive AML/CFT powers; ASIC and AUSTRAC roles need legislative clarification and enhancement. - Disclosure and issuer regime: - Prospectus and disclosure framework is principle-based; ASIC to issue a comprehensive Policy Statement on prospectus disclosure (work under way). - Timelines and specific numeric thresholds preserved (examples): - Exempt offers thresholds: less than A$2 million in a 12 month period; offers to fewer than 20 investors. - Sophisticated investor threshold: minimum amount payable A$500,000. - Substantial holding disclosure: 5 percent first declaration; subsequent 1 percent moves require disclosure; Section 671B(6) disclosure deadlines preserved (two business days or by 9:30 am next trading day during a takeover bid). - Market infrastructure and exchanges: - Licensing of markets and CSFs resides with the Minister (with ASIC advice); suggested consideration to transfer licensing to ASIC to streamline regulation. - ASX accounts for over 99 percent of equities trading; derivatives and clearing regulated with RBA collaboration for stability standards. Payments systems — RITS and CPSS assessment (selected findings and metrics) - RITS overview and activity: - RITS introduced as RTGS in June 1998; owned and operated by the RBA. - 60 participants in RITS (2005). - On average settled 24,000 transactions daily with an average daily value of $A 150 billion (2005). - Four major banks account for 67 percent of volume and value of total RTGS transactions. - RITS average annual availability statistics (examples preserved): - 99.98 percent for 2002; - 99.91 percent for 2003; - 99.94 percent for [year indicated but text ends]. - Legal and operational assessments: - Legal basis: Reserve Bank Act 1959, Payment Systems (Regulation) Act 1998, Payment Systems and Netting Act 1998 — assessment: Observed. - Settlement asset: central bank money (claims on RBA via ESAs) — assessment: Observed. - Credit and liquidity risk controls: RTGS settlement in ESAs with intraday repurchase agreements for liquidity; queueing algorithm with bilateral auto-offsetting; indicator: total liquidity need around AUD 8 billion; daily settlement value averaged $A 150 billion — assessment: Observed. - Finality/irreversibility: protected by Payment Systems and Netting Act; payments irrevocable upon settlement — assessment: Observed. - Security, operational reliability and contingency: robust governance with hot backup site, recovery benchmarks (recovery within 15 minutes for component failure; full recovery within 40 minutes after decision to failover; 60 minutes if staff relocation required); availability consistently high — assessment: Observed. - Pricing: flat fee per transaction of $A 0.88 charged to each debit and credit; RBA studying pricing and intended review in 2006. - Recommended RITS actions (verbatim recommendations preserved): - Require entities located outside the Australian jurisdiction applying for participation in RITS to provide a legal opinion analyzing possible conflict of laws and potential legal risk to RITS and its participants. - Require security enhancement of the proprietary communication network to meet international standards regarding confidentiality, integrity and authenticity. - Consider an external review of the RBA’s business continuity plan including assessment of hardware, software and internal procedures. - Consider consulting RITS users on costs and pricing and reviewing the pricing structure to ensure efficient functioning. - Consider establishing a consultative framework with users representing different categories of RITS participants. - Consider whether current arrangements avoid potential conflicts of interest between the PSB’s policy/oversight functions and the Bank’s role as operator of RITS; strengthen PSB oversight by developing formal methods and procedures. Action plans and key recommended reforms (selected, preserved intent) - AML/CFT and CP 15: - Amend Financial Transaction Reports Act 1988 to allow AUSTRAC to share FTR information with APRA; implement an MoU between AUSTRAC and APRA; build AUSTRAC on-site verification capacity (two year build-up expected). - Ensure APRA receives information essential to assess reputational and liquidity risks within APRA regulated institutions. - Scope of regulation / Sec 11 exemptions: - Revise criteria for Sec 11 exemptions so only truly wholesale-funded institutions are exempted; clarify demarcation between authorized and exempted institutions; ensure foreign bank subsidiaries undertaking bank-like activity are subject to APRA oversight. - APRA governance and independence: - Consider removing Treasurer’s power to give directions to APRA or clarify circumstances; recommended public disclosure of reasons for removal of APRA Members; maintain operational independence during transition to FMA Act and ensure exemptions preserve independence. - Supervisory practices: - Introduce greater standardization in off-site analytical reporting to reduce variation in quality while maintaining risk-based judgment. - Consider expanding APRA authority to require information from subsidiaries and related entities where necessary to supervise on a consolidated basis. - Insurance sector: - Implement Potts Review recommendations on DOFIs and DMFs; give APRA explicit cross-border supervisory powers; harmonize APRA powers across banking and insurance to improve remedial effectiveness. - Securities sector: - ASIC to issue consolidated Policy Statement on prospectus disclosure; consider whether licensing of markets and CSFs should be transferred to ASIC; consider funding changes and possible industry levies to improve ASIC funding stability and independence. - Payments: - Improve RITS communication network encryption and pursue external review of business continuity; consult users on pricing; require legal opinions for foreign participants. Selected exact numeric values and thresholds (preserved) - Financial system assets: over 300 percent of GDP. - ADIs: 238. - Largest five banks: some 74 percent of assets. - Stock market capitalization: over 100 percent of GDP. - APRA staff: 612. - APRA staff turnover: some 20 percent per year. - Bank minimum Tier 1 capital for use of “bank” title: $A 50 million. - Building society Tier 1 capital minimum: $A 10 million. - Capital adequacy statutory minima: 4 percent tier 1 capital; 8 percent total capital (APS 110, s7). - APRA typical assessed capital ratios: often between 10 and 20 percent depending on risk profile. - Reporting standards: APRA has determined 43 reporting standards under the Financial Sector (Collection of Data) Act. - RITS participants: 60; average daily transactions: 24,000; average daily value: $A 150 billion. - RITS transaction fee: $A 0.88 per debit and credit. - DOFIs and DMFs market share per Potts Review industry data: 0.5 percent of the Australian insurance market. - ASIC register: 4,091 AFSL holders and over 45,000 registered authorized representatives (as of April 2005). - ASX domestic listed companies: 1,774; market capitalization: $A 975 billion at end-June 2005. - OTC turnover (2004/5): exceeded $A 58 trillion; on-exchange turnover: $A 24 trillion. - ASX average daily equities turnover (2004–05): some $A 3.2 billion; 78 percent institutional. - FATF Mutual Evaluation (October 2005): found AML/CFT supervisory implementation shortcomings in Australia. Italic: Excerpted and summarized from the IMF Financial Sector Assessment Program — Australia (assessment chapter and related sections) contained in content unit _cr06415. ### 1. Principle by Principle Assessment of Basel Core Principles.................................................9 ### 1. Principle by Principle Assessment of Basel Core Principles.................................................9 ### General - Assessment completed as part of a Financial Sector Assessment Program undertaken in December 2005 by the International Monetary Fund. - Review covers legal framework and detailed examination of policies and practices of institutions responsible for banking supervision. - Australia uses a functional approach to oversight, with roles divided by regulatory objective: - Australian Prudential Regulation Authority (APRA): prudential supervision of banks, insurers and superannuation funds. - Australian Securities and Investments Commission (ASIC): market conduct regulator and administrator of company law for listed and unlisted companies. - Reserve Bank of Australia (RBA): payment system oversight and overall financial stability. - Australian Transaction Reports and Analysis Centre (AUSTRAC): federal financial intelligence unit (FIU) and AML/CFT regulator. - Treasury: preparation of laws and regulation, policy advice to the Treasurer; Treasurer may issue directions to APRA and ASIC. - Attorney-General’s Department: preparation of AML/CFT laws and regulation and policy advice to the Minister for Justice and Customs. ### Information and Methodology Used for Assessment - Assessment team reviewed legal framework, held extensive discussions with APRA, ASIC, the RBA, the Treasury, and market participants, and examined APRA’s on-site and off-site supervision. - Assessment benefited from a comprehensive self-assessment by Australian authorities and full cooperation from counterparts. - Assessment team members named: Michael Andrews (IMF-MFD Consultant) and Göran Lind (Sveriges Riksbank). - Conclusions required judgments; adhered to a common, agreed methodology to provide a reliable measure versus Core Principles. - Qualitative four-part assessment system used: compliant; largely compliant; materially non-compliant; non-compliant. - "Compliant": all essential criteria generally met without any significant deficiencies. - "Largely compliant": only minor shortcomings observed; not sufficient to raise serious doubts. - "Materially non-compliant": shortcomings sufficient to raise doubts, but substantive progress had been made. - "Non-compliant": no substantive progress toward compliance. ### Preconditions - Preconditions for effective banking supervision are well established in Australia. - Over two decades Australia implemented wide-ranging structural reforms and strengthened monetary and fiscal frameworks, yielding rising incomes, strong job creation and high productivity growth. - Economic expansion that began in 1992 is now in its fourteenth year. - Unemployment rate has fallen by 6 percentage points since 1992. - Inflation has remained low and net public debt has been all but eliminated. - Financial system size and composition: - Financial system assets amount to over 300 percent of GDP. - Authorized deposit-taking institutions (ADIs: banks, credit unions, and building societies) account for about half of total financial system assets. - A further 23 percent of assets are held by life insurers and superannuation funds. - Stock market capitalization is over 100 percent of GDP. - Banking system composition: - 238 ADIs, including: - 14 Australian-owned banks - 11 foreign subsidiary banks - 28 branches of foreign banks - 14 building societies - 158 credit unions - 3 specialist credit card institutions - 3 ADIs that provide services to member building societies and credit unions - Largest five banks held some 74 percent of assets. - Credit unions and building societies total assets comprise less than 2 percent of total ADI assets. ### Monetary Policy Framework - Power to determine monetary policy conferred on the Board of the RBA by the Reserve Bank Act 1959. - RBA Board required to conduct monetary policy to best contribute to: stability of the currency of Australia, maintenance of full employment, and economic prosperity and welfare of the people. - RBA Board conducts monetary policy independently of the Government; confirmed in the Statement on the Conduct of Monetary Policy agreed in 1996 and reaffirmed and updated in 2003. - Statement includes a commitment by the RBA to hold consumer price inflation to between 2 and 3 percent, on average, over the course of the cycle. - Monetary policy is conducted through the cash rate; open market operations keep the cash rate at or near an operating target decided by the RBA Board. ### Currency Regime - Australian dollar floated in 1983 and acts as a key economic shock absorber, moving broadly with external demand and commodity prices. ### Disclosure Arrangements - Listed companies subject to a modern continuous disclosure regime. - ADIs subject to specific disclosure requirements including publication of annual reports. - APRA prescribes key disclosure elements: governance and risk-management arrangements, audited financial statements. - APRA publishes financial statement information on the industry. ### The Legal System - Commonwealth of Australia is a federal system: Commonwealth Government, six State Governments and two Territory Governments. - Australian Constitution (1901) establishes Federal government and separation of powers among Parliament, the Executive government, and the Judiciary. - APRA operates in accordance with Commonwealth law; winding up of banks carried out under Commonwealth law. - Legislative power vested in Parliament; proposed legislation must be passed by both Houses to become law. - Executive administers law; Acts often confer power to make regulations, rules and by-laws. - Australia subject to the rule of law: openness of courts, judicial independence, presumption of innocence; English common law and equitable principles are foundations. - Court system: Federal and State/Territory arms; High Court of Australia holds judicial powers of the Commonwealth. - Corporate insolvency under Corporations Act focused on orderly realization of assets and equitable distribution to creditors, employees and shareholders. - Three types of external administration: liquidation, receivership and voluntary administration. - Directors legally obliged to cause an insolvent company to cease trading or risk personal liability. ### Accounting and Auditing - From January 2005, Australia adopted International Financial Reporting Standards (IFRSs) issued by the IASB. - Some Australian-specific accounting standards retained for issues such as disclosure of director and executive remuneration, and concise financial reports. - Listed companies required to lodge annual and half-yearly financial reports with ASIC; financial statements must be prepared in accordance with IFRS and provide a true and fair picture. - Annual accounts must be audited; half-yearly reports are subject to either review or audit. - Large non-listed companies required to lodge annual statements with ASIC; some relief to non-listed "non-reporting companies"; exemptions for small non-listed companies. - Auditor registration: - To audit a listed company, auditor must be registered under the Corporations Act. - ASIC must form the opinion that the applicant has necessary qualifications, satisfies auditing competency standard, and is capable of performing auditor duties. - Oversight of auditors provided by ASIC and professional accounting bodies. - Disputes over auditor behavior decided by the Companies Auditors and Liquidators Disciplinary board. - There are currently 6110 registered auditors. - Auditing standards established by the Auditing and Assurance Standards Board (AUASB), based on International Standards on Auditing (ISAs). - Financial Reporting Council oversees the AUASB and the AASB. ### Prudential Regulation Framework - Prudential regulation of ADIs, insurance companies, and superannuation funds is undertaken by APRA. - APRA’s objective: ensure that, under all reasonable circumstances, financial promises made by regulated entities are met within stable, efficient and competitive financial markets. - Australia’s prudential framework is risk-based and based on consultative dialogue between supervisors and regulated entities. - Framework recognizes management and boards as primarily responsible for financial soundness; regulatory intervention is proportionate to problem seriousness and risk to policyholders and industry. ### Mechanisms for Dealing with Problem Banks - APRA’s supervisory powers escalate from preventative, through corrective, to failure management: - Preventative powers: authorization framework, tests of fitness and propriety, implementation of prudential standards. - Correction powers: court-enforceable undertakings (agreements between APRA and market participants), issuing of directions to supervised entities; in serious/immediate cases APRA can seek court injunctions. - Failure management powers: ability to apply for transfer of business of an entity in financial distress to a healthy institution; to initiate external administration; and to initiate wind-up. - RBA as lender-of-last-resort: - RBA able to provide emergency liquidity to distressed ADIs. - Stated policy: RBA would consider lending to an ADI only if it viewed the failure as a systemic threat. - RBA would not be willing to extend liquidity support to an insolvent institution. - Government deposit guarantee stance: - Government has not decided whether to introduce an explicit depositor guarantee. - Presently, depositor preference exists in ADIs: in liquidation, depositor claims are given priority over other claims on the estate. - HIH Insurance failure: Government responded on a discretionary basis to compensate policy holders. - In two cases of near-failures of banks owned by State governments, their respective owners ensured that all creditors’ claims were met. - Historical government intervention has created the impression of an implicit government guarantee of deposits. ### Detailed Assessment - The principle-by-principle assessment follows, with APRA’s powers and their use in practice addressed in more detail in subsequent sections. *Source: Assessment completed as part of a Financial Sector Assessment Program undertaken in December 2005 by the International Monetary Fund.* ### 27. This assessment has been completed against the Core Principles essential criteria, ### _cr06415 - 27. This assessment has been completed against the Core Principles essential criteria, ### Overview - Assessment completed against the Core Principles essential criteria (FSAP standard). - Australia assessed as having a high level of compliance with both the essential and additional criteria. - Areas noted as leading edge: capital adequacy and risk-based supervision. ### Principle 1. Objectives, autonomy, powers, and resources — Summary Assessment - Assessment: Compliant. - Overall comment: Five of six subcomponents fully complied with; CP 1(6) assessed as “largely compliant” but shortcoming not severe enough to downgrade CP 1 overall. #### Principle 1(1) — Clear responsibilities and legal framework - Description highlights: - Banking Act 1959 (BA) is basis for banking regulation. - APRA established under Australian Prudential Regulation Authority Act 1998 (APRA Act); powers in section 11. - RBA regulates payment system (Reserve Bank Act 1959). - AUSTRAC enforces Financial Transaction Reports Act 1988. - ASIC monitors corporations under Australian Securities and Investment Commission Act 2001. - Treasurer/Treasury responsible for legislative framework and Financial Sector (Shareholdings) Act 1998 administration. - Prudential instruments: - Sec 11AF BA empowers APRA to issue ADI Prudential Standards (APS); tabled in Parliament for 14 days and approved on a no-objections basis. - Prudential Standards not legally binding per se, but APRA can use Sec 11CA(1) BA to issue legally binding directions, including for breach of any Prudential Standard. - APRA issues Practice Guidance notes (not legally enforceable but require explanation if not followed). - Sec 11A allows legally-binding regulations; Treasurer must consult APRA; proposals tabled for five days before approval on a no-objections basis. - APRA powers under BA: revoke license (9A); issue directions (11CA); appoint investigator/administrator/statutory manager (13A/13C); take control when depositor repayment threatened. - APRA publications: quarterly “Insight”, monthly “Banking Statistics”. - Assessment: Compliant. #### Principle 1(2) — Operational independence and resources - Assessment: Compliant. - Key points: - APRA formally independent and accountable to government and Parliament. - Ministerial direction power under Sec 12 APRA Act limited to policies/operational priorities; cannot apply to particular cases (Sec 12(1) and Sec 12(3)). Direction must be written, APRA given opportunity to discuss, published in Gazette within 21 days, tabled before Parliament within 15 sitting days. - No instances of ministerial direction observed. - APRA financed by levies on supervised entities; levies determined/collected by government and allocated to APRA without specific use conditions. - APRA staff count: 612 (includes all APRA tasks for ADIs, insurance companies and superannuation schemes). - APRA staff turnover: some 20 percent per year; identified as concern for institutional memory and continuity. - APRA Members appointed up to terms not exceeding 5 years (Sec 20 APRA Act); removal governed by Sec 25 with specified reasons; no legal requirement to publicly disclose reasons for removal. - Government proposal: move APRA from CAC to FMA subject to exemptions; assessors note potential restrictions on operational independence if exemptions not granted. - Recommendation: Formal legal requirement to publicly disclose reasons for removing an APRA Member from office recommended. #### Principle 1(3) — Authorization and ongoing supervision - Assessment: Compliant. - Key points: - Sec 9(3) and 9A BA identify APRA as authority to grant/revoke banking licenses. - Sec 11AF and Sec 11CA(1) enable Prudential Standards and directions. - Sec 13 Financial Sector (Collection of Data) Act enables APRA to determine reporting standards; APRA has determined 43 such standards. - Sec 62 BA empowers APRA to obtain any required information from banks/holding companies; Sec 13 BA enables information on financial stability. #### Principle 1(4) — Powers to address compliance and safety - Assessment: Compliant. - Key points: - Sec 11CA BA grants wide powers of direction; Division 2 BA empowers intervention when bank’s ability to repay depositors threatened. - Sec 13(3) BA requires immediate notification to APRA if a bank likely to be unable to meet obligations or suspend payment. - Directors must notify APRA of breaches or circumstances with material impact; Sec 62A BA makes failure to notify an offence. - APRA uses risk-based supervision with PAIRS (Probability and Impact Rating System). - Sec 62 BA and Sec 11 APRA Act (“do anything necessary or convenient”) provide information and action powers. #### Principle 1(5) — Legal protection for supervisors - Assessment: Compliant. - Key points: - Sec 58(1) APRA Act: APRA, APRA Members, or staff not subject to liability for actions/omissions in exercise of powers/functions/duties except acts in bad faith. - No specific legislation to indemnify APRA or staff for legal costs; APRA assists staff in defending actions and has resolved to indemnify Members and staff as required. - Legal costs covered by insurance cover and Deed of Indemnity for APRA Members. - Recommendation: APRA should have written policies on assisting Members or staff in legal actions for transparency and equal treatment. #### Principle 1(6) — Information sharing and confidentiality - Assessment: Largely compliant. - Key points: - APRA participates in councils/committees with ASIC, RBA, Treasury, AUSTRAC; Council of Financial Regulators (CFR) coordinates main agencies. - MOUs with ASIC, RBA, Treasury; MOUs with foreign supervisors: UK/FSA, New Zealand/RBNZ, Hong Kong/HKMA, Germany/BaFin, China/CBRC, US/OTS. - Sec 56 APRA Act empowers release of confidential information to other supervisory agencies (including foreign) with confidentiality maintained by recipient; offence to disclose confidential information. - APRA cannot be compelled by court to release protected information; Sec 56(11) exempts APRA from FOI Act 1982 disclosure. - Limitation: APRA may provide information to AUSTRAC but is not permitted to receive information from AUSTRAC. - Comment/Recommendation: AUSTRAC should be permitted to share general information with APRA where relevant (e.g., indications of inadequate internal controls in ADIs). ### Principle 2. Permissible activities - Assessment: Largely compliant. - Key points: - Sec 5 BA defines “banking business” (taking of money and making advances or other prescribed financial activities). - All entities carrying on banking business must obtain authorization under Sec 9 BA or exemption under Sec 11. - Only authorized institutions with at least $A 50 million in Tier 1 capital or branches of foreign banks may describe themselves as “banks”; others are “authorized deposit-taking institutions” (ADIs). - Sec 11 exemptions apply to wholesale institutions; exempted institutions must disclose they are not APRA supervised and not covered by depositor preference; may not advertise deposit facilities. - APRA reviewing Sec 11 exemption policy to ensure significant deposit-takers are within prudential framework. - Comment: Some exempt institutions offer deposit-like facilities (e.g., “at call debentures”) — review recommended to ensure exemptions limited to truly wholesale funders. ### Principle 3. Licensing criteria - Assessment: Compliant. - Licensing powers and criteria: - Sec 9 BA empowers APRA to grant/reject authorities to carry on banking business; impose conditions; revoke authorities (Sec 9A(2) for false/misleading information). - APRA publishes Guidelines on Authorization of ADIs; detailed criteria: capital, ownership, management, risk management, information/accounting systems, internal/external audit, home supervisor supervision for foreign banks. - BA requires banks to have at least $A 50 million in Tier 1 capital. - Applicants must submit three-year business plan and three-year projections with sensitivity analysis (expected, upside, downside) for balance sheet, cash flow, earnings, and key ratios on solo and consolidated basis. - APS 510 - Governance, APS 520 and 521 (draft) on fit and proper for directors/senior managers/auditors; notifications required within 28 days for changes/adverse determinations. - Foreign banks require home supervisor consent and adequate home prudential supervision. - Practice: New entrants subject to early onsite visit; higher capital requirements set for new entrants; ADIs engaging ASIC-regulated activities must obtain ASIC “Code of conduct” license. ### Principle 4. Ownership - Assessment: Compliant. - Key points: - Financial Sector (Shareholdings) Act 1998 (FSSA) limits individual shareholdings in financial sector companies (including banks) to 15 percent unless exception granted. - Ownership interests broadly defined to include controlling interest or influence; restrictions apply to new banks and changes in ownership. - Treasurer may revoke or vary approvals; Treasurer delegated powers under Sec 44 FSSA to APRA for banks with total assets under $A 750 million. - All shareholdings >5 percent must be disclosed in annual report. - Practice: APRA advises Treasurer on transactions above delegated limits; no instance of Treasurer acting against APRA recommendation. ### Principle 5. Investment criteria - Assessment: Compliant. - Key points: - APRA detailed assessment of acquisitions/new business; APS 222 - Associations with Related Entities sets approval/prior notification requirements. - Consultation required before establishing/acquiring subsidiary or interest >10 percent in finance-related entity. - Prior approval required to establish/acquire another regulated presence or to exceed exposure concentration limits. - APS 222 restricts acquisitions of equity in non-financial companies except via work-outs; equity associations must be reported (s4a APS 222). - APRA assesses strategic rationale, funding/impact on capital, integration, governance, risk systems, and home supervisor consent for overseas acquisitions. - Thresholds for referral to APRA are low — most acquisitions/investments must be referred. ### Principle 6. Capital adequacy - Assessment: Compliant. - Key points and explicit figures: - APS 110 - Capital Adequacy sets framework consistent with Basel Capital Accord. - s7 APS 110 requires minimum risk-weighted capital ratio of 4 percent (tier 1 capital) and 8 percent (total capital). - Typical APRA-assessed required ratios often between 10 and 20 percent depending on risk profile; APRA may set higher required ratios at any time. - Summary on capital adequacy: - Statutory requirement: 8 percent, of which 4 percent must be tier 1 capital. - APRA assessment generally leads to an expected capital ratio higher than 8 percent; for some ADIs considerably higher. This APRA-assessed ratio is not legally enforceable itself, but failure to reach it could cause intensified monitoring or APRA direction to make it legally binding. - A "capital buffer" could be added by APRA if ADI judged vulnerable to more than normal volatility. - ADI required to calculate its own "economic capital." - APS 111 defines capital base components; APS 112 and APS 113 determine risk-weighted exposures for credit and market risk respectively. - Reporting: ARF 110.0 requires quarterly detailed capital reporting. - Minimums by institution type: - Institutions using the word "bank": at least $A 50 million in tier 1 capital or be branches of foreign banks. - ADIs authorized as "building societies": at least $A 10 million in tier 1 capital. - Comment: APRA’s capital requirements reflect best international practices, including elements aligned with Basel II implementation. ### Principle 7. Credit policies - Assessment: Compliant. - Key points: - APS 220 requires board and management to ensure effective credit risk management and regular review. - Supervisory verification via on-site prudential reviews guided by APRA’s Supervision Framework Module 8 (credit risk management, credit approval/underwriting standards, concentration, risk grading, problem assets). - APRA’s guidance: APS 222 and guidance notes 220.1–220.4 detail asset quality identification and credit granting/investment processes. - On-site reviews include review of credit files for directors/related parties and credit committee composition; PAIRS used for risk rating. ### Principle 8. Loan evaluation and loan loss provisioning - Assessment: Compliant. - Key points: - APS 222 and guidance notes 220.1–220.4 establish asset classification and provisioning requirements. - External auditors review provisioning under Australian accounting standards (IFRS from January 2005) with APRA guidance. - Impaired assets definition includes off-balance sheet exposures (AGN 220.1 paragraphs 6-8). - Banks may use internal modeling for specific provisioning or adopt prescribed standardized approach. - Regulatory powers: BA division 1BA gives APRA authority to issue directive directions; failure to comply with direction is a criminal offence. - Reporting: Quarterly reporting on impaired assets and provisioning; ARF 220.0 and AGN 220.4 cover internal rating and provisioning reporting. - Impaired asset objective measures: non-accrual when provision made, write-down taken, or facility 90 days past due. ### Principle 9. Large exposure limits - Assessment: Compliant. - Key points: - APS 221 requires boards to ensure policies to identify/manage concentrations; “large exposure” defined as 10 percent of capital. - Prudential limits (paragraph 9 APS 221): - 25 percent of capital for non-government, non-bank, unrelated parties; - 50 percent of capital for unrelated banks; - 50 percent of capital for foreign parents and their subsidiaries, with aggregate exposure to non-deposit-taking subsidiaries capped at 25 percent of capital. - APRA may grant exceptional approvals to exceed limits (paragraph 13); at end-November 2005 fewer than five such approvals in force. - Reporting: ARF 221.0 requires quarterly reporting on exposures exceeding 10 percent of capital on solo and consolidated basis. - Additional portfolio concentration reporting: commercial property (ARF 230.0), international exposures (ARF 231), geographic by state/territory (ARF 391.0), commercial finance (ARF 394.0), personal finance (ARF 395.0). Sectoral data via ARF 395.0 Business Finance Statistics. ### Principle 10. Connected lending - Assessment: Compliant. - Key points: - APS 222 defines related entities as those controlled directly or indirectly by the bank or its parent; APRA may deem other entities related. - Definition does not explicitly capture individuals (officers/directors); exposures to these governed by general credit risk standards. - Banks required to deal with related parties on arm’s-length basis (APS 222 paragraph 10); board approval needed for dealings inconsistent with unrelated party benchmark (paragraph 11). - Limits (paragraph 27 APS 222) and potential higher minimum capital (paragraph 29) for exposures to related entities: - Related non-bank regulated entities: limits more lenient (35 percent of level 1 capital) than unrelated non-bank entities (25 percent of capital). - Exposure limits examples: 50 percent of level 1 capital for exposure to a related ADI; 150 percent of level 1 capital aggregate for all such exposures; individual related unregulated entities limited to 15 percent of level 1 capital; individual related regulated non-ADI entities limited to 25 percent of level 1 capital; total exposure to all related non-ADI entities limited to 35 percent of level 1 capital. - Reporting: ARF 222.0 quarterly reporting on related party exposures. - Comment: Recommend expanding definition of related parties to explicitly include individuals (officers, directors, persons related to or closely associated with such persons). ### Principle 11. Country risk - Assessment: Compliant. - Key points: - No specific prudential standard for country/transfer risk; expected to be captured within APS 220 credit risk framework and Module 8 of Supervision Framework. - Module 8 requires policy for acceptable country exposures (geographic and size limits) and consideration of legal system, political stability, economic climate, social stability, FX controls, bankruptcy laws. - Reporting: ARF 231 (international exposures) and ARF 325 (international operations) quarterly. - Comment: Preferable to promulgate a prudential standard specifically addressing country and transfer risk. ### Principle 12. Market risks - Assessment: Compliant. - Key points: - APS 113 requires boards to adopt strategies/policies for identification, measurement, and control of market risks. - AGN 113.3 The Standard Method prescribes capital calculation methodology for market risks; AGN 113.2 Internal Models sets minimum criteria for internal models and requires APRA approval. - Eight ADIs approved to use internal models for market risk; one authorization subsequently revoked. - Banks hold capital for market risks via Standard Method or approved internal model; APS 110 paragraph 8 allows APRA to require capital above minimum. - APRA has specialist Risk Models unit and specialist market risk supervisory teams; internal model users subject to back-testing and periodic APRA-specified standard portfolio exercises. - On-site reviews include front office, middle/back office, IT, accounting, internal/external audit; APRA has required remedial action when board oversight inadequate (e.g., 2004 revocation of NAB internal model authorization pending 84 remedial measures). - Comment: APRA has developed a highly skilled specialist team for market risk supervision. ### Principle 13. Other risks (liquidity, operational, interest rate, securitization, outsourcing, business continuity) - Assessment: Compliant. - Key points: - APS 310 requires annual CEO declaration endorsed by board that key risks identified and systems established and operating effectively. - Specific prudential standards/guidance: APS 210 (funds management and securitization), APS 221 (liquidity), APS 231 (outsourcing), APS 232 (business continuity), credit and market risk standards previously noted. - Liquidity: APS 210 requires liquidity management strategy approved by board and APRA, group-wide and all currencies addressed. AGN 210.1 and AGN 210.2 provide guidance on scenario testing and minimum liquidity holdings. - Simplified liquidity requirement: institutions whose scale/complexity do not warrant sophisticated techniques may, with APRA concurrence, comply with requirement to maintain a minimum of 9 percent of liabilities in specified high-quality liquid assets; currently only credit unions and building societies are subject to this simplified 9 percent limit. - Specialized operational risk and IT on-site teams support frontline supervisors; sample reports thoroughly completed. - APRA can require additional capital for specific risks. ### Principle 14. Internal control and audit - Assessment: Compliant. - Key points: - APS 310 and draft APS 510 address governance and internal control responsibilities of board and management. - On-site reviews pursuant to Module 6 of Supervision Framework assess delegations, separation of duties, MIS, accounting, internal audit adequacy. - APS 310 requires locally incorporated banks to have comprehensive and independent internal audit (paragraph 11); smaller ADIs may have alternative arrangements with APRA (paragraph 12) — exemptions granted only to building societies and credit unions using qualified accounting firms for outsourced internal audit. - Audit committee requirement: majority non-executive directors; draft APS 510 would require all audit committee members to be non-executive. - APRA may direct removal of director or senior manager not meeting fit and proper requirements (Section 20 BA). *Source: IMF assessment text in content unit _cr06415 - 27. This assessment has been completed against the Core Principles essential criteria,* ### Section 62 of the BA provides APRA with the legal authority to obtain any information ### _cr06415 - Section 62 of the BA provides APRA with the legal authority to obtain any information ### Section 62 legal authority and access to internal audit reports - Section 62 of the BA provides APRA with the legal authority to obtain any information required for supervisory purposes. - In practice, APRA has not had to rely on formal powers to obtain access to reports of internal audit functions. - Assessment: Compliant. - Comments: The essential and additional criteria of this principle are met by the current prudential standards. The changes proposed in the current draft of APS 510 would further strengthen governance practices. ### Principle 15 — Prevention of Use of the Bank by Criminal Elements - Principle summary: Banks must have adequate policies, practices and procedures, including strict “know-your-customer” rules, to promote high ethical and professional standards and prevent use by criminal elements. - Description and institutional roles: - Licensing guidelines and fit-and-proper requirements for directors and senior management are focal prudential measures. - AUSTRAC has a dual role as an FIU and AML/CFT regulator; as AML/CFT regulator it is responsible for ensuring compliance with AML/CFT legislation, including on-site verification. - The FTR Act requires cash dealers (a defined term under the FTR Act, which includes ADIs) offering accounts to obtain necessary identification verification information from all signatories to accounts. - No specific requirement in either the prudential framework or the FTR Act to appoint a senior officer with explicit responsibility for ensuring compliance with anti-money laundering requirements; AUSTRAC recommends appointment of a senior officer. - APRA Supervision Modules contain no specific references regarding systems and procedures for reporting of suspicious transactions. - AUSTRAC is empowered to conduct on-site verification but has focused mostly on education and has conducted two compliance examinations in respect of banks during the last two years. - Legal provisions and information sharing: - Section 13 of the BA requires an ADI to notify APRA of any matter which would threaten its ability to meet its obligations to depositors. - Section 16 of the FTR Act provides legal protection of cash dealers and their employees in the submission of suspicious transaction reports. - The FTR Act (section 27 11A) permits AUSTRAC to share information with foreign supervisory bodies and FIUs, but it is currently unable to share suspicious transaction information with APRA. - The APRA Act (section 56) authorizes APRA to disclose protected information to other supervisory agencies and any other agency specified in the regulations, which includes law enforcement agencies. - There is no explicit requirement for banks to have a policy statement on ethics and professional behavior communicated to all staff. - FATF findings: - FATF published its October 2005 Mutual Evaluation Report on Australia documenting shortcomings in the legal framework and finding that “did not find the implementation of the AML/CFT supervisory system to be effective in terms of the standards required by the revised 40 Recommendations.” The report noted a need for enhanced coordination of AML/CFT measures among relevant authorities. - Assessment: Materially non-compliant. - Comments — principal shortcomings and verification needs: - Principal shortcomings relate to the absence of an effective regime of on-site verification. - Revised legislation is in preparation to address legal shortcomings. - AUSTRAC is expected to build over a two year period the capacity for on-site verification. - Most essential criteria require on-site verification. Achieving compliance requires on-site verification that banks have actually implemented appropriate and effective measures, including verification of: - Banks’ policies and procedures for high ethical standards and prevention of use by criminal elements (EC 1); - Documented and enforced procedures for identification of customers (EC 2); - Formal procedures to recognize potentially suspicious transactions (EC 3); - Banks’ appointment of a senior officer to ensure compliance with statutory requirements (EC 4); - Banks’ procedures clearly communicated to all staff for the reporting of suspicious transactions (EC 5); - Banks have established lines of communication to both management and internal security for reporting problems (EC 6); - Banks’ internal processes and controls for anti-money laundering are sufficient (EC 9). - Effective coordination and communication between AUSTRAC and APRA is vitally important; APRA must be appropriately advised and able to take action to address general prudential concerns arising from AUSTRAC’s on-site work at ADIs. ### Principle 16 — On-site and off-site supervision - Principle summary: Effective supervision requires both on-site and off-site components. - Description of APRA’s approach: - APRA uses an integrated approach: off-site analysis by frontline supervisors and on-site prudential reviews by the same frontline supervisors, joined by supporting specialists (e.g., IT, operational risk, market risk, credit risk) as required. - Off-site work includes regular quarterly analysis, annual review, PAIRS risk assessments and assessment of prudential issues as they arise. - External auditors are required by APS 310 to report annually on the accuracy of data submitted to APRA; off-site verification of data is supported by the statistics unit. - Financial analysis draws on prudential and statistical reports; detailed reports are produced for individual banks and aggregate/peer group analysis is performed. - Frequency, prioritization and tools: - Frequency of on-site reviews determined by minimum review cycles and risk-based prioritization driven by PAIRS and SOARS. - PAIRS classifies institutions on probability of failure and potential impact; each institution is assigned one of five PAIRS ratings: Low, Low Medium; High Medium; High or Extreme. - SOARS transforms PAIRS into a supervision strategy; combination of PAIRS rating and bank size yields one of four supervisory stances: Normal; Oversight; Mandated Improvement; or Restructure. - APRA Supervision Framework outlines methodology and module selection for prudential reviews. - Systems and resourcing: - Supervisory activity supported by the Activity and Issue Management System (AIMS) to record and track all prudential reviews and activities. - APRA has formal legal powers to access internal and external auditors’ reports (BA and APS 310). - Assessment: Compliant. - Comments: - Variation in quality of reports likely due to high staff turnover and lack of standardized quarterly report approach. - APRA should consider benefits of a more standardized approach for consistency and comparability. ### Principle 17 — Bank management contact - Principle summary: Supervisors must have regular contact with bank management and a thorough understanding of operations. - APRA practices: - Extensive program of regular meetings with bank management at various levels, including annual meetings with CEOs and functional heads to review APRA’s assessment. - Ongoing meetings with senior executives related to on-site and off-site reviews and as issues arise. - APRA expects immediate notification by banks of any material adverse development to their risk positions; failure to notify can negatively affect APRA’s risk assessment and may attract enforcement action. - APS 222 explicitly requires banking groups to notify APRA immediately after becoming aware of any breach of a prudential standard requirement or a condition of a banking authority and of any circumstances that might reasonably be seen as having a material impact and potentially adverse consequences. - APRA Supervision Framework (Module 2) requires explicit assessment of quality of bank management, including composition, structure and fit-and-proper tests; PAIRS includes rating of senior management quality. - Assessment: Compliant. ### Principle 18 — Off-site supervision - Principle summary: Supervisors must collect, review and analyze prudential reports and statistical returns on a solo and consolidated basis. - Legal and reporting framework: - BA and paragraph 13 of the Financial Sector (Collection of Data) Act used to determine 43 reporting requirements, which are quarterly or annual, and apply on both consolidated and solo bases. - Legal powers enable APRA to specify form and content of required reporting. - Prudential standards place responsibility on boards and senior management for risk management and prudential reporting. - Division 3 of the Financial Sector (Collection of Data) Act empowers APRA to impose criminal sanctions penalties in lieu of prosecution for failure to comply. - Data scope and usage: - The 43 mandated prudential reports provide balance sheet and income statement data, details on on- and off-balance sheet activities, composition of capital, and data on asset classification and provisioning. - APRA’s authority does not currently extend to banks’ unregulated related companies, but in practice APRA receives full cooperation from banks on group operations. - APRA could use powers (including section 11AF of the BA) to require subsidiaries to submit required information if not voluntarily provided. - Prudential data feed into PAIRS risk-rating assessments; banks provide additional material in preparation for on-site work. - APRA collects data quarterly and annually in standardized form for peer group analysis; sample semi-annual reports on smaller ADI sectors were of good standard. - Assessment: Compliant. ### Principle 19 — Validation of supervisory information - Principle summary: Supervisors must independently validate supervisory information via on-site exams or external auditors. - APRA validation framework: - Supervisory Framework establishes risk-focused on-site examinations with clear responsibilities; integrated approach includes frontline supervisors and technical specialists. - Prudential reviews organized around Modules; frequency determined by supervisory stance (PAIRS/SOARS). - External auditors undertake targeted reviews and review reliability of data reported to APRA; regular tripartite meetings (APRA, external auditor, bank) are held. - APS 310 requires auditors to provide management letters and specific reporting information; paragraphs 15–18 provide for appointment of auditors to undertake “specific reviews” (cost borne by institution) and empower APRA to require additional information. - Division 2B of the BA empowers APRA to remove a bank’s external auditor (responsible partner or firm). - APS 310 paragraph 16 references Accounting Standard 904 for the role of external auditors in “specific reviews.” - APS 310 paragraph 13 requires external auditors to report annually to APRA on whether the financial and statistical data provided by the ADI is accurate and reliable. - APRA’s Statistic Unit reviews reported data for consistency and common errors prior to release to supervisors; supervisors routinely query large or material movements and require resubmission if incorrect. - APRA does not generally meet with boards of directors, but may do so for particularly serious on-site issues; APRA meets quarterly with major accounting firms via the Auditor Liaison Group. - Assessment: Compliant. ### Principle 20 — Consolidated supervision - Principle summary: Supervisors must be able to supervise banking groups on a consolidated basis. - APRA’s consolidated supervision practices: - APRA has detailed understanding of banking group structures and material activities. - APS 222 requires banks to provide details of group members, management structure, intra-group support arrangements and intra-group exposures (paragraph 4). - APRA must be notified in advance of intended changes that could materially alter group risk profile; sample major acquisition file indicates this occurs in practice. - Groups must annually provide APRA with group risk management policies and procedures used to measure and manage group risk exposure (paragraph 5). - APRA adopts a group-wide focus for conglomerate groups; sample quarterly analysis reports include solo and group discussions; APS 222 references risks from non-bank activities. - APRA has wide powers to supervise banks and affiliates under the BA and APS 222; APRA’s prudential supervision of insurance and pension entities is supported by powers under the Insurance Act, Life Insurance Act, and Superannuation Industry (Supervision) Act. - APRA staff maintain a good working relationship with ASIC; practical information flow between supervisory authorities exists though scope for improvement is noted. - No impediments to supervision of affiliates and subsidiaries; banks are supervised on solo, consolidated banking group, and conglomerate group bases as required. - Major prudential standards (e.g., APS 110) apply on both consolidated and solo bases; sample quarterly reports included capital adequacy analysis on both bases. - APRA routinely collects consolidated financial information for locally incorporated banks and full financial information for branch operations in Australia. Prudential reporting under the Financial Sector (Collection of Data) Act applies on both solo and consolidated bases. *Source: _cr06415 - Section 62 of the BA provides APRA with the legal authority to obtain any information* ### Section 11CA of the BA provides APRA with broad powers to direct banks to take or refrain ### Section 11CA of the BA provides APRA with broad powers to direct banks to take or refrain ### APRA's directive powers and corporate ownership - Section 11CA of the BA grants APRA broad powers to direct banks to take or refrain from taking specific actions; these powers could be used in practice to ring-fence a regulated entity. - Such powers can be used to limit the range of activities the consolidated banking group may conduct or to restrict its overseas operations. - The Financial Sector (Shareholdings) Act generally prohibits corporate ownership of locally owned banks beyond a maximum of 15 percent of voting shares, except where provisions allow exceeding this limit if in the national interest. - A corporate owner would have to be authorized as a holding company under the BA. - Assessment: Compliant. ### Principle 21 — Accounting standard - IFRS (International Financial Reporting Standards) promulgated by the IASB were enacted as Australian law from 1 January 2005; there are no "carve-outs" for Australian ADIs and they will implement IFRS in full (with a few insignificant additions for ADIs that do not infringe on IFRS). - Corporations Act responsibilities and requirements: - Bank management is responsible for financial record keeping systems and the reliability of data produced. - Banks must maintain proper financial records, subject them to independent audit, and ensure disclosure is adequate and in accordance with Australian Accounting Standards. - All annual financial statements must be in accordance with Australian Accounting Standards; the annual financial report and directors' report must be audited. - Reports must be lodged within 3 to 4 months after the end of the financial year depending on the type of entity. - APRA reporting and audit framework: - ADI Reporting Standards (ARS) require submission of information to APRA and place responsibility on board and senior management for authorization of data submitted. - APS 310 requires external auditors to provide simultaneously to APRA and the audit committee a report on whether statistical and financial data provided to APRA are reliable. - APRA reviews management information systems and data during on-site reviews and may engage external auditors to undertake specific audits of banks’ accounts; APRA may require that a bank submit its annual financial report to APRA prior to lodgment with ASIC and can require changes. - Sec 17 BA empowers APRA to remove a person, or the whole audit firm, from auditing a bank if performance or fit-and-proper criteria are not met. - All information supplied to APRA is protected under Sec 56 APRA Act, with provisions allowing sharing with other supervisory bodies. - APRA supports transparency and statutory disclosure of financial information to enhance prudential objectives. - Assessment: Compliant. ### Principle 22 — Remedial measures - APRA has a wide range of powers under the BA to address non-compliance or unsafe practices, enabling prompt remedial action and sanctions. - Typical supervisory responses: - Increase frequency and intensity of supervisory oversight. - Require higher capital ratios for an individual bank. - Require discontinuation of certain lines of business. - Require more frequent reporting from the area causing concern. - Examples of directions under Sec 11CA BA include: - removing or restricting the powers of a director, executive, secretary or employee; - appointing a person to act as a director, executive, secretary or employee of a bank; - replacing an internal auditor; - placing restrictions on a bank's activities and acquisitions; - restricting or suspending dividends or repayment of shares; - restricting repayments or asset transfers; and - directing anything else as to the way in which the affairs of the bank are conducted, or not conducted. - APRA may revoke a bank's license if warranted and could participate in arranging a takeover or merger of a troubled bank provided it is not a material detriment to the healthier institution. - Supervisory tools and processes: - Continuous off-site monitoring; risk-based on-site reviews. - PAIRS risk-rating tool, SOARS response system, and the APRA Supervision Framework support timely and proportionate remedial actions. - Senior executive group receives a monthly report on risk ratings and recent downgrades/upgrades. - Sec 11BA creates offences for bank officers failing to take reasonable steps to ensure compliance with an APRA direction. - No "cooling off" periods apply to remedial powers; judicial review is available but not a rehearing on the merits. - APRA acts proactively, e.g., increasing capital requirements for individual banks. - All requirements and instructions are given in writing; progress is typically reported in writing; significant issues are addressed to the bank's board; on-site reviews are followed by written findings specifying required/recommended/suggested actions. - Assessment: Compliant. - Comment: Consideration is being given to whether APRA remedial decisions might be submitted to "merit review" in addition to existing "judicial review"; this requires careful structuring so as not to compromise APRA’s ability to act forcefully and promptly in urgent crises. ### Principle 23 — Globally consolidated supervision - APRA supervises all operations of locally incorporated banks and their subsidiaries, whether in Australia or overseas, under global consolidated banking supervision. - APRA's policies and practices: - "Conglomerates policy" to strengthen consolidation. - Boards are required to ensure appropriate policies, systems and procedures to monitor group-level compliance with APRA prudential requirements. - On-site reviews examine group-wide activities and assess board and head office oversight of overseas operations. - For banks with significant offshore operations (noted in practice: New Zealand and the UK), APRA conducts on-site reviews of the local office and liaises with the host supervisor. - On-site reviews of credit, market and operational risk include verifying that information from overseas entities is sufficient and internal controls and head office oversight are effective. - APRA powers abroad: - Can require divestment of businesses or branch offices, place limits on activities, or take measures abroad to ensure compliance or protect depositors’ interests when warranted (e.g., insufficient group-level monitoring, weak host supervision, or lack of required information due to host country secrecy laws). - Where additional risk is identified, APRA increases frequency and intensity of on-site reviews and reporting. - Assessment: Compliant. ### Principle 24 — Host country supervision - APRA has MOUs with several host supervisors to establish cooperation, information exchange, and investigative assistance; specifically noted MOUs with the Reserve Bank of New Zealand and the Financial Services Authority (UK), and with the Hong Kong Monetary Authority; BaFin (Germany); China Banking Regulatory Commission; and the Office of Thrift Supervision (USA). - APS 222 requires banks to advise APRA in advance of proposed group changes that could materially alter risk profile and to obtain APRA's prior approval for establishment/acquisition of a regulated presence domestically or overseas. - APRA can prohibit proposed overseas operations it deems too risky using BA powers. - APRA meets host supervisors during on-site reviews and promptly contacts host supervisors when concerns arise; prudential assessments and reports on bank groups are often exchanged with foreign supervisors. - APRA always liaises closely with host supervisors before taking action in respect of overseas operations. - Assessment: Compliant. ### Principle 25 — Supervision over foreign banks' establishments - Local branches and subsidiaries of foreign banks authorized by APRA are subject to similar prudential, inspection and regulatory reporting requirements as domestic banks. - Sec 11 BA exemption: - Australian law (Sec 11 BA) permits foreign banks to operate in Australia without APRA authorization and supervision, provided they disclose to counterparties that they are not supervised by APRA; such institutions may not accept deposits otherwise than by issuing or selling securities in accordance with the Corporations Act. - Licensing considerations: - APRA assesses home country supervisors’ prudential oversight and whether consolidated global supervision is practiced when considering authorization; APRA will not authorize a bank to conduct banking business in Australia without consent from its home supervisor. - Information sharing: - APRA can share relevant information with overseas regulators for licensed foreign banks but this does not extend to exempted foreign banks operating under Sec 11 BA. - APRA facilitates requests from home country supervisors to examine Australian operations of foreign banks and advises home supervisors of material issues or prudential interventions affecting authorized foreign banks. - APRA obtains relevant information on global activities of foreign banks during licensing and ongoing supervision; prudential assessments and reports are frequently exchanged between home and host supervisors. - Assessment: Largely compliant. - Key statistics and observations: - The foreign deposit-taking institutions outside APRA's regulation have aggregate assets of $A 77 billion compared with the prudentially regulated sector's total assets of 2.1 trillion. - Few of these exempt institutions have assets in excess of 1 billion and thus are not regarded as systemically important, though some are of significant size within Australia and failures could affect the regulated sector and depositors. - Assessors' concerns and recommendation: - The possibility to grant "Sec 11 exemptions" opens a wide door that might lead to regulatory arbitrage; some exempt institutions may offer deposit-like instruments to retail customers despite formal limitations. - Given blurred boundaries between wholesale and retail banking, a fairly wide sector of non-regulated entities conducting quasi-banking activities may create level-playing-field issues and complicate globally consolidated supervision. - Assessors recommend introducing an amended and clearer demarcation line between authorized and exempted institutions that better reflects current financial market structures and instruments, with clearer criteria applying to liabilities (funding) side and to the range of permitted activities. ### Summary of compliance with Basel Core Principles (selected items) - Principle 1. Objectives, Autonomy, Powers, and Resources — Compliant - Principle 6. Capital Adequacy — Compliant - Principle 16. On-Site and Off-Site Supervision — Compliant - Principle 21. Accounting Standards — Compliant - Principle 22. Remedial Measures — Compliant - Principle 23. Globally Consolidated Supervision — Compliant - Principle 24. Host Country Supervision — Compliant - Principle 25. Supervision Over Foreign Banks’ Establishments — Largely compliant *Excerpted and summarized from the supplied IMF assessment text.* ### 28. Australia has already initiated plans to address the most serious shortcomings in the ### _cr06415 - 28. Australia has already initiated plans to address the most serious shortcomings in the ### AML/CFT supervision and CP 15 (Use of banks by criminal elements) - Australia has initiated plans to address the most serious shortcomings in implementation of the Basel Core Principles for Effective Banking Supervision relating to Core Principle 15. - Intended actions: - AUSTRAC will develop the necessary skills and expertise to undertake on-site verification of banks’ implementation of measures to prevent abuse by criminal elements. - Coordination and information sharing between AUSTRAC and APRA is described as vital because many specific requirements of CP 15 extend beyond narrow AML/CFT issues. - Risks if information sharing is constrained: - If AUSTRAC cannot share information with the prudential supervisor, effective implementation of measures to ensure APRA is apprised on a comprehensive and timely basis will be impaired (for example, reputational risk). - APRA would not receive full benefits of insights into broader issues of internal control and compliance from AUSTRAC’s detailed on-site reviews. ### APRA operational independence and governance (Principle 1(2) and related) - Current assessment: - Provisions to ensure operational independence of APRA fall short of those of the RBA but currently provide a generally adequate framework to meet Core Principles. - The power of the Treasurer to give directions to APRA has not been used. - Recommendations and observations: - Removing the Treasurer’s power to give directions would provide greater certainty regarding independence of the prudential supervisor. - Making APRA subject to the Financial Management and Accountability Act could lead to diminution of operational independence; preferable to maintain status under the Commonwealth Authorities and Companies Act. - Authorities’ response: - The Government considers the Treasurer’s power to issue directions on policies and priorities (but not particular cases) strikes an appropriate balance; conditions such as discussing the proposed direction with the APRA Chair and tabling the direction in parliament provide transparency and accountability. - The Treasurer has agreed to move APRA’s financial framework to the Financial Management and Accountability Act 1997 (FMA Act) from the Commonwealth Authorities and Companies Act 1997 (CAC Act). - Government view: the change to the FMA Act will not materially affect APRA’s operational independence or funding. APRA’s enabling legislation (the Australian Prudential Regulation Authority Act 1998) establishes required operational independence. - The Government has exempted APRA from a small number of conditions under the FMA Act that may affect its ability to fulfill duties efficiently and effectively. - Government emphasizes its approach to fiscal policy over the last decade ensuring adequate funding while sustaining fiscal discipline. ### Scope of regulation and Section 11 exemptions (CP 2 and CP 25) - Concern: - Current criteria for Section 11 exemptions may allow institutions that do not fund themselves on a truly wholesale basis to be exempted from APRA regulation and supervision. - There is little practical difference between unlicensed and unsupervised finance companies and foreign bank subsidiaries that fund themselves using instruments issued by prospectus which may be mistaken by retail investors as deposits. - Recommended action: - Revise criteria for Section 11 exemptions to ensure only institutions funding themselves on a truly wholesale basis may be exempted. - Amend demarcation line between authorized and exempted institutions to better reflect today's financial market structures and instruments. - Ensure all subsidiaries of foreign banks undertaking bank-like activity in Australia are subject to APRA oversight. ### APRA supervisory approach and off-site analysis (CP 25 / supervisory practices) - Assessment: - APRA’s PAIRS/SOARS approach reflects current best practices in risk-focused supervision and is commendable. - The approach is still new and subject to ongoing refinement. - Recommendation: - Introduce greater standardization in off-site analysis to reduce variation in quality and to provide staff with greater guidance shaping supervisory judgment, while avoiding a check-list mentality. ### Recommended Action Plan (excerpted table entries) - CP 1(6): Information sharing - Remove legal obstacles to AUSTRAC sharing information with APRA and implement effective coordination regarding information gathered by AUSTRAC relevant to APRA’s prudential oversight of banks’ internal policies. - CP 2: Permissible activities - Revise criteria for exempting institutions from regulation so that the demarcation line between regulated and non-regulated entities becomes clearer. - CP 15: Use of banks by criminal elements - Establish an effective supervisory verification program, ensuring APRA can obtain all necessary information regarding prudential issues, including those beyond AUSTRAC’s mandate. - CP 25: Supervision Over Foreign Banks’ Establishments - Revise criteria for exempting institutions to ensure all foreign bank subsidiaries undertaking bank-like business in Australia are subject to APRA oversight. ### Legislative and policy developments, timelines, and procedural changes - AML/CFT reform and information sharing: - Government commitment to update Australia’s AML/CTF regime to reflect developments in financial crime and revised FATF standards. - Legislation is expected to be introduced during 2006. - Processes are in place to amend the Financial Transaction Reports Act 1988 to allow AUSTRAC to share FTR information with APRA; this will involve a memorandum of understanding between the two authorities. - Under proposed AML/CFT legislation APRA will be included as a partner agency with which AUSTRAC can share FTR information. - These arrangements aim to ensure APRA is provided with information essential to assessing reputational and liquidity risks within APRA regulated institutions. - Merits review (Principle 22): - Government is reviewing the application of merits review to APRA decisions following recommendations from the HIH Royal Commission and the Taskforce on Reducing the Regulatory Burden on Business. - Review will consider the need for APRA to take timely decisions to protect depositors and/or other policyholders, and balance timeliness with fairness. In absence of merits review, affected persons have recourse to judicial review. ### Insurance Core Principles (ICP) assessment methodology and scope - Assessment context: - The assessment examines Australia’s observance with ICP issued by the IAIS in October 2003. - The assessment was conducted by Su Hoong Chang from November 30 to December 14, 2005 as part of the IMF FSAP and is based on the IAIS assessment methodology. - Observance levels: - Observance for each ICP reflects assessment of essential criteria only; advanced criteria are not included. - Definitions provided: - Observed: all essential criteria observed or all observed except some considered not applicable. - Largely observed: only minor shortcomings exist. - Partly observed: shortcomings raise doubts about ability to achieve observance. - Not observed: no substantive progress toward observance. - Assessment basis: - Separate assessments for life and general industries where applicable. - Assessments based on: a) comprehensive self-assessment by authorities; b) review of laws, regulator guidance and procedures; c) analysis of regulatory and market data; d) interviews with authorities, industry participants, associations; e) documentation from interviewees. - Assessments reflect laws, regulations and supervisory practices in place at time of assessment; ongoing reforms noted as additional comments where not yet fully implemented. *Source: IMF FSAP assessment content as presented in the provided chapter excerpts.* ### 37. The mission is grateful to the Treasury, APRA, ASIC and ATO for their full ### Table 4. Principle by Principle Assessment of IAIS Core Principles ### Conditions for Effective Insurance Supervision (Principle 1) - Description: - Australia has a sophisticated macro-economic framework. Sound fiscal and monetary policies have contributed to a stable environment conducive for the development of well functioning financial markets. - Australia adopts a functional approach to financial sector regulation: prudential supervision under APRA, investment market integrity and transparency through ASIC and broader financial system stability through the Reserve Bank. - APRA is to balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality. - The legal system is robust; courts provide an effective mechanism for settlement and enforcement of contractual obligations. - International Financial Reporting Standards (IFRS) was adopted as from 1 January 2005. - Auditing standards are set by the Auditing and Assurance Standards Board (AUASB), based on International Standards on Auditing. - Oversight of auditors is by ASIC and the professional bodies; there are currently approximately 6,110 registered auditors. - The Corporations Act (as from 1 July 2004) requires an auditor to give the auditor's independence declaration to directors at the same time as the auditor's report. - Life Insurance Actuarial Standards Board (LIASB) establishes actuarial standards; compliance is obligatory for life insurers. Actuaries must qualify as Fellows of the Institute of Actuaries of Australia (IAAust). - Economic, financial and statistics data are widely available; publications by APRA on the insurance industry are detailed under ICP 11. - The four prescribed stock exchanges have total stock market capitalization of almost US$500 billion. - Australia has the eight largest stock market in the world and the second largest in the Asia-Pacific region behind Japan. - Advanced Criteria / Reforms: - Corporate Law Economic Reform Program (CLERP) began in 1997; CLERP 9: the Corporate Law Economic Reform Program (Audit Reform & Corporate Disclosure) Act 2004 became law on 30 June 2004. - APRA initiatives include Stage 2 Reform for general insurance industry and development of a comprehensive framework for prudential supervision of conglomerates. - Assessment: - Observed - Comments: Australia has sophisticated and progressive macroeconomic and legal supervisory frameworks; adopts international accounting and auditing standards; deep, liquid and well functioning financial markets facilitate effective asset-liability management by insurers. ### The Supervisory System (Principles 2–5) - Principle 2. Supervisory objectives - Description: - Objectives are clearly enunciated in the Insurance Act (IA) and the Life Insurance Act (LIA): main object is to protect interests of policyholders and prospective policyholders consistent with continued development of a viable, competitive and innovative insurance industry. - Additional object under the LIA: “to protect the interests of persons entitled to other kinds of benefits provided in the course of carrying on life insurance business”. - APRA’s main objective is to minimize failures among APRA regulated financial institutions; “Failure” means failure to meet expected payments to depositors, policyholders and super fund members (beneficiaries). APRA cannot guarantee no failures. - ASIC’s objective: “achieve the outcome of a fair and efficient market characterized by integrity and transparency and supporting confident and informed participation of investors and consumers”. - Axiss Australia established separately for financial sector development. - Assessment: - Observed - Comments: Objectives clearly defined and transparent; APRA and ASIC need effective coordination to balance prudential and conduct-of-business supervision. - Principle 3. Supervisory authority - Description: - APRA responsible for general administration of insurance legislations; Treasury handles financial sector policy formulation and reforms. - APRA has wide powers to make standards; may give directions to insurers; contravention of a direction is an offence. - APRA must seek the Treasurer’s agreement before taking actions in a number of administrative areas (e.g., ownership in excess of 15 percent in financial sector companies and freezing an insurer’s assets). - ASIC has no power to create legal obligations; interprets laws through guidelines and preferred practices and may impose licensing conditions. - APRA is an independent statutory authority headed by an executive Chairman and governed by three APRA Members appointed by the Governor General on advice of the Minister. - Minister has a formal power of direction under section 12 of the APRA Act limited to policies and operational priorities; direction must be in writing and tabled before Parliament within 15 sitting days. No instances of formal direction to APRA. - APRA’s decisions are subject to substantive judicial review under the Administrative Decisions (Judicial Review) Act 1997 (ADJR Act) and Administrative Appeal Tribunal (AAT). - APRA is subject to Parliamentary Standing Committees, Senate Estimates hearings, Senate Select committees, and audits by the Australian National Audit Office (ANAO). - APRA financed from levies on regulated entities; autonomy to apply levy funds and set organizational structure and staffing. - Government consideration to place APRA’s financial arrangements under the Financial Management and Accountability Act (FMA) instead of Commonwealth Authorities and Companies Act (CAC) with potential implications for APRA autonomy. - Internal oversight: Risk Management and Audit Committee (external chair with casting vote), Supervisory and Technical Decision Making Procedures, record-keeping (AIMS). - IA requires extensive consultation before making prudential standards; LIASB follows due process for actuarial standards. APRA prepares Regulation Impact Statements (RIS) for new or amended prudential standards. - APRA’s Code of Conduct, protections from liability when acting in good faith, indemnity under the Commonwealth Authorities and Companies Act 1997. - Under APRA Act, disclosure of “Protected Information” is limited; offence to disclose except in specified situations; protected information retained status even if communicated to another supervisor. - Specific powers (General insurance): - APRA empowered to license general insurers, revoke authorization, make prudential standards and exercise monitoring and enforcement powers under Parts IIIA and V of the Act. - Powers subject to Treasurer’s agreement include: power to wind-up general insurer (not provided under the IA but under Corp Act); directions under sections 49M and 49N to require provisions in accounts; restriction from issuing new or renewing policies when an investigation is underway; actions to revoke a general insurer’s authority. - Specific powers (Life insurance): - APRA can register and monitor compliance, investigate affairs, appoint a judicial manager or seek winding-up. - Powers subject to Treasurer’s agreement include: refusal to register a life insurer; withdrawal of license; giving directions on solvency and capital adequacy of statutory funds and management capital requirements; give notice in relation to maintenance of statutory funds under Part 4; direction under section 150 of the LIA to not issue further policies if under investigation and unable to meet liabilities or contravened LIA/direction. - Failure to comply with prudential standards is not an offence but may lead to a direction under section 230B; contravention of a direction is an offence under section 230F. APRA may prescribe prudential rules and require compliance via direction under section 230B. - Assessment: - Largely observed - Comments: APRA has wide powers and resources; ASIC lacks rule-making powers. Scope exists to review extent of Treasurer’s involvement affecting APRA operational independence; APRA has adequate powers and financial resources; strong safeguards for confidential information; appointment/removal processes for APRA members noted with no requirement to publicly disclose reasons for removal. - Principle 4. Supervisory process - Description: - APRA conducts continuous off-site analysis through annual and quarterly assessments; on-site review frequency determined by minimum review cycles and risk-based prioritization. - Risk prioritization based on PAIRS (Probability and Impact Rating systems) and SOARS (Supervisory Oversight and Response System). - PAIRS assesses: a) inherent risks – insurance, counterparty, market, operational, liquidity, legal/regulatory, strategic and related party; b) effectiveness of management and controls; c) capital support as buffer; d) overall risk. PAIRS ratings: Low; Low Medium; High medium; High; or Extreme. - SOARS translates PAIRS into supervision strategy and determines supervisory stance: Normal; Oversight; Mandated Improvement; and Restructure. - Normal supervision activities: assessment of regular data, monitoring market intelligence, on-site and off-site reviews, formal PAIRS assessment. - Actions for Restructure: forced sale and/or forced run-off. Mandated Improvement actions may include: imposition of license conditions or statutory directions; appointment of an Inspector; giving of an Enforceable Undertaking; closure to new business/freezing assets; disqualification of key personnel; civil litigation; criminal prosecution brief to the DPP. - Institutions are informed of PAIRS ratings and consequent supervisory actions. - PAIRS and SOARS supported by APRA Supervision Framework (ASF), AIMS and Supervisory and Technical Decision Making Procedures. - Enforcement unit supervises high-risk entities and handles issuing directions, enforceable undertakings, investigations or freezing of assets; Enforcement Committee decides corrective/enforcement actions. - Administrative decisions subject to judicial review under ADJR Act; review available for bad faith, irrelevant considerations, unreasonableness, denial of natural justice, or inflexible policy application. - Prudential standards, rules, guidelines and determinations published on APRA’s website; APRA prepares an annual report within four months after end of financial year. - Advanced Criteria: - APRA publishes Insight quarterly, Quarterly General Insurance Performance Statistics, Life Insurance Trends (quarterly) and Life Office Market Report (six-monthly). - APRA designing a more comprehensive semi-annual publication with detailed individual insurer and aggregate industry information. - Assessment: - Observed - Comments: APRA has instituted a risk-based supervisory approach supported by rigorous internal documentation and procedures; timely enforcement facilitated by Enforcement unit and Committee; supervisory decisions transparent and subject to independent judicial review; APRA publishes role, activities and market analysis on its website. - Principle 5. Supervisory cooperation and information sharing - Description: - APRA participates in councils, committees and working groups with ASIC, the Reserve Bank, the Treasury and AUSTRAC to coordinate regulatory interventions and supervision. - APRA, ASIC, Reserve Bank and Treasury are members of the Council of Financial Regulators (CFR) — an informal high-level forum for cooperation. - ASIC and APRA entered into a Memorandum of Understanding (MOU) in June 2004 and established a joint Coordination Committee responsible for information sharing, joint inspections, task forces, referrals for enforcement action, and coordination to avoid duplication in data collection. - Enforcement liaison meetings are held monthly. Operational liaison meetings are held bi-monthly in Sydney and Perth and quarterly in Melbourne and Brisbane. Routine liaison occurs as needed. - MOU provides notification and consultation on proposed regulatory policy or decisions likely to impact the other agency; agencies may consult on policy statements and media releases. - In November 2005, APRA and ASIC jointly released Unit Pricing – guide to good practice for life insurance, superannuation and fund management industries. - In the past 12 months, ASIC made 116 releases to APRA and APRA made 164 releases to ASIC. - Before ASIC suspends or cancels an AFSL issued to an insurer regulated by APRA, ASIC must first consult APRA; no legal obligation for APRA to consult ASIC before taking action on an insurer’s license. - APRA has MOUs with other domestic and overseas supervisors; disclosure powers under APRA Act not subject to reciprocity; disclosure of protected information permissible for prudential regulation or to assist other supervisors; disclosure by recipients is an offence under the APRA Act. - APRA will notify and consult the source supervisor before acting on information received from another supervisor; will notify relevant overseas supervisors if actions materially affect insurer’s overseas operations; will inform home supervisor before acting on Australian branch or subsidiary of a foreign insurer. - Assessment: - Observed - Comments: Domestic coordination facilitated through councils and MOUs; CFR provides high-level cooperation; MOU between ASIC and APRA establishes joint Coordination Committee; consideration should be given to ensuring APRA consults or notifies ASIC when taking action on an insurer’s license where appropriate; APRA cooperates fully with overseas counterparts. ### The Supervised Entity (Principle 6. Licensing) - Description: - Insurers must hold two licenses: a license from APRA and an AFSL from ASIC. - Composite insurers are not allowed under the IA and LIA. - Reinsurers and captive insurers are licensed under the IA and LIA in the same manner as primary insurers. - Private Health insurers are not licensed and regulated by APRA; Department of Health and Ageing has primary responsibility; related agencies include Private Health Insurance Administration Council, Private Health Insurance Ombudsman, ACCC, ASIC, ATO, Health Insurance Commission and APRA (in relation to friendly societies). Private health insurance is supplementary to Medicare and subject to product and pricing controls; private health insurers will not be assessed against the ICPs. - APRA has a Cross-Divisional Licensing Group to ensure consistent licensing practice across industries. - For foreign applicants, APRA requires a statement from the home supervisor confirming approval to conduct operations in Australia, consolidation supervision and willingness to cooperate with APRA. - General Insurance licensing specifics: - It is an offence to carry on general insurance business in Australia without authorization. - Insurance business definition includes undertaking liability by way of insurance (including reinsurance) and incidental businesses. - APRA may refuse an application on prudential grounds. - APRA’s power to deal with unauthorized entities is limited; prosecutions under sections 9 and 10 of the IA must be referred to the DPP; APRA cannot obtain an injunction to restrain unauthorized entities. - Guidance Note Guidelines on Authorisation of General Insurers sets minimum criteria: fit-and-proper for shareholders and key positions; ability to comply with prudential requirements; satisfactory risk management including reinsurance; 3-year business plan; product and group structure details. - IA allows licensing of foreign branches or subsidiaries; Guidelines stipulate supervision by home supervisor; authorized foreign branch/subsidiary must meet statutory IA requirements. - Direct Offshore Foreign Insurers (DOFIs) are not licensed by APRA and not subject to APRA prudential supervision because business functions are not conducted in Australia; DOFIs must hold an AFSL from ASIC and disclose non-APRA authorization when providing services to retail clients. - Discretionary Mutual Funds (DMFs) provide insurance-like products with no legal obligation to meet costs; DMFs are not subject to IA as they do not meet the “insurance business” definition. - Review of DMFs and DOFIs commenced 12 September 2003 (Potts Review); Government released key findings on 27 May 2004 and agreed to implement recommendations; Treasury consulted widely thereafter. - The Potts Review reported that DOFIs and DMFs accounted for approximately 2.5 percent and - [content ends here in source] - Assessment: - (Assessment text for Principle 6 continues in source beyond provided excerpt.) *Source: IMF mission text as provided in the content unit.* ### 0.5 percent of the Australian insurance market, based on data provided by the industry in ### 0.5 percent of the Australian insurance market, based on data provided by the industry in ### Market structure and market share of DOFIs and DMFs - Based on data provided by the industry to the Potts Review, DOFIs and discretionary mutual funds (DMFs) had insignificant roles in the insurance market, quantified as 0.5 percent of the Australian insurance market. - The industry indicated to the assessors that the market share of DOFIs has been increasing since 2003. - The industry raised concerns that DOFIs have been increasing their market share since 2003. - DOFIs, which provide general insurance covers in Australia, are not licensed and not subject to prudential supervision by APRA; they are required to hold an AFSL from ASIC and must disclose that they are not APRA-authorized when providing services to retail consumers. - The Government has agreed to implement the Potts Review recommendation that DMFs offer cover only as a contract of insurance under the IA unless APRA considers that there is no contingent risk to be met by additional undefined members’ contributions. ### Regulatory response and the Potts Review recommendations - The Government has yet to release its formal response to the Potts Review recommendation that: - a) DOFIs be exempt from prudential regulation in Australia if they are domiciled in a country APRA considers to have comparable prudential regulation, subject to a market significance threshold; - b) APRA to have enhanced enforcement and investigative powers against DOFIs; - c) APRA to assume a data collection role in relation to offshore insurers. ### APRA supervisory scope and cross-border supervision - The IA currently does not directly apply to insurance activities carried on outside Australia by subsidiaries of insurers domiciled in Australia. - APRA has the ability to regulate Australian-based companies with overseas operations via the authorization of Non-operating Holding Company (NOHC). - Draft proposals released in May 2005 would extend APRA’s supervisory net to include overseas operations. - APRA considers that it observes EC (d) on regulation of cross-border establishments in practice, but this is not supported by legal provisions and may be subject to legal interpretation and review by the AAT. - There is no similar proposal for life insurance in extending cross-border supervisory powers. ### Life insurance: registration, statutory funds, and foreign entry - LIA prohibits companies from issuing life policies or carrying on life business without registration. Life insurance business means the issuing of life policies and the undertaking of liability under life policies. - Applications for registration should furnish particulars including: managerial structure; business plan with sample premium rates, particulars of reinsurance and financing of new business; operational structure; investment policy; outsourcing arrangements; and details of the administrative and accounting systems. - The application must be accompanied by written advice from the appointed actuary about the terms and conditions and reinsurance arrangements plus service agreements for all outsourced functions. - Life insurers shall establish statutory funds exclusively in respect of life insurance business carried on outside Australia. - Foreign life insurers could only carry on life insurance businesses in Australia through locally incorporated subsidiaries, except for “eligible foreign life insurance company”. - Under the US-Australia Free Trade Agreement concluded in 2004, life insurers incorporated and conducting life insurance business in the US are eligible to conduct life insurance business in Australia through branches. There has not been any application from an eligible foreign life insurance company. - APRA’s refusal to register a company needs the Treasurer’s approval; in practice, registration applications are assessed against the same benchmarks as for banking and general insurance licenses. ### Principle 7 — Suitability of persons (fit and proper) - Description: - Significant shareholdings and control governed by the Financial Sector (shareholdings) Act (FSSA) and the Insurance Acquisitions and Takeovers Act 1991 (IATA). - FSSA requires ownership stakes in excess of 15% in a financial sector company to be approved by the Treasurer; IATA applies to proposals to acquire 15% or more of an Australian-registered insurance company. - The Treasurer has delegated powers under FSSA and IATA to APRA staff, subject to size limitations: for life companies, total assets must not exceed $A 5 billion; for general insurers, total assets must not exceed $A 1 billion. - The FSSA allows the Treasurer to revoke any approval previously granted and to apply to the Court to order disposal of shares. - Recent measures: - On 2 March 2006, APRA released new and harmonized 'fit and proper' prudential standards for all its regulated institutions, including general and life insurers. - Key elements of the new standards include: - an insurer must implement a written fit and proper policy that meets APRA requirements; - the fitness and propriety of a responsible person must be assessed prior to taking up appointment with the insurer and re-assessed annually thereafter; - insurers must not allow anyone assessed as not fit and proper to hold a responsible person position; - additional requirements for certain auditors and actuaries; - APRA be provided with certain information regarding the responsible persons assessed as fit and proper by an insurer. - General insurance specifics: - The IA defines a “disqualified person”. Fitness and propriety criteria are set out in Prudential Standard GPS 220 Governance. - APRA should be notified immediately if a key person no longer complies with the tests of fitness and propriety. - Life insurance specifics: - LIA disqualifies bankrupts and convicted persons from serving as director, principal executive officer or appointed actuary. - APRA may give direction to a life insurer to remove a director, executive officer, employee, the approved auditor or approved actuary. - Assessment: - Observed for life insurance and partly observed for general insurance (earlier comment); with the formalization of fitness and probity framework in March 2006, both the life and general insurance regimes fully observe ICP 7. ### Principle 8 — Changes in control and portfolio transfers - Description: - The Treasurer’s national interest test applies under FSSA and IATA; in practice proposals are assessed by APRA against licensing criteria including fitness and propriety and financial capacity. - Under FSSA and IATA, a person’s stake is the aggregate of the person’s voting power and the voting power of the person’s associates; FSSA defines “associates” and related control concepts. - Neither FSSA nor IATA exempts overseas persons; proposals may need separate approval from the Foreign Investment Review Board. - APRA assesses changes in control as if they were initial license applications; structures that hinder effective supervision are unacceptable. - Group-wide supervision is limited under the current solo supervisory regime but proposals to extend the supervisory framework to corporate groups involving insurers are being implemented. - The Financial Sector (Transfer of Business) Act 1999 (FSTB Act) requires APRA to have regard to the interests of policy owners of transferring and receiving bodies; the Court requires an actuarial report to confirm transfers. - General insurance: - APRA approves any portfolio transfer under the IA; Prudential Standard GPS 410 Transfer and Amalgamation of Insurance Business for General Insurers applies. - Life insurance: - LIA prohibits transfer or amalgamation of life insurance business except under a scheme confirmed by the Court, or where the transfer is made under the FSTB Act. - Assessment: - Observed. Legislation sets clear ownership and control thresholds above which approval is required; APRA assesses delegated applications and provides input where the Treasurer exercises authority. ### Principle 9 — Corporate governance - Description: - APRA assesses board and management quality in on-site prudential reviews; every insurer must have an approved actuary and an appointed auditor. - APRA expects insurers to have a compliance function with clearly established roles and responsibilities. - Directors of insurers are obliged under the Corps Act to exercise due care and diligence; listed insurers are subject to ASX Principles of Good Corporate Governance and Best Practice recommendations with an “if not, why not” reporting approach. - On 5 May 2006, APRA released new and harmonized prudential standards on governance for all regulated institutions, including general and life insurers. Key requirements cover: - Board size and composition; - Mandatory Audit committee; - Dedicated internal audit function; - Auditor independence; - Board renewal and performance assessment. - General insurance specifics: - Prudential Standard GPS 220 Risk Management for General Insurers details Board responsibilities for audit, actuarial functions, internal controls and risk management; senior management responsibilities are defined. - The Board must provide the approved auditor and approved actuary the opportunity to raise matters directly with the Board; the approved actuary must provide the actuarial report on liabilities in time for the Board to use in preparing annual statutory accounts. - Life insurance specifics: - The appointed actuary has access to necessary information and must report to directors any matter that may prejudice policyholders’ interests. - Assessment: - Observed. The May 2006 formalization of the corporate governance framework brings the Australian regime into full observance of ICP 9. ### Principle 10 — Internal control - Description: - APRA’s prudential reviews are modular and include management, structure and relationships; risk management; and operational risk, tailored to the nature, size and complexity of the institution. - In reviewing actuary and auditor reports, APRA focuses on comments on the strength of the insurer’s internal control processes. - The Corps Act requires directors to use care and diligence and act in good faith in the best interests of the corporation and for a proper purpose (sections 180 and 181), ensuring adequate supervision of market conduct activities. - Assessment: - APRA exercises internal control oversight through on-site prudential reviews and off-site monitoring; internal control assessment is integrated into supervisory practice. *Source: IMF staff extract from _cr06415 - 0.5 percent of the Australian insurance market, based on data provided by the industry in_* ### Section 912A of the Corps Act also imposes obligations on directors of entities that hold AFSLs ### Section 912A of the Corps Act also imposes obligations on directors of entities that hold AFSLs ### Directors' obligations and AFSL monitoring - Section 912A of the Corps Act imposes obligations on directors of entities that hold AFSLs to have adequate monitoring systems in place to supervise market conduct activities. - ASIC expects the AFSL holder to have appropriate systems in place to monitor its compliance with the Corps Act and the obligations and conditions attached to the license and has powers to revoke or suspend an AFSL. ### General insurance — Governance and risk management (GPS 220 and related guidance) - Prudential Standard GPS 220 Risk Management for General Insurers requires the Board to “ensure that an appropriate, adequate and effective system of risk management and internal control is established and maintained” and “use its best endeavors to ensure that senior management monitors the effectiveness of the risk management and control system.” - Guidance Note GGN 220.2 Risk Management Systems provides minimum standards relating to: - a) clearly defined management responsibilities; - b) adequate segregation of duties; - c) a risk committee or audit function; - d) a system of approvals, limits, authorizations and reporting lines; - e) policies to document the insurer’s procedural controls; - f) activity controls for each division or department; - g) verifications of activities such as underwriting, pricing and claims management, and reconciliations; - h) reviews by Board, senior management and internal audit; and - i) physical controls. - APRA has released a draft prudential standard requiring an actuary to provide the Board with an FCR (Financial Condition Report), which provides an assessment of the key risks and issues impacting on the financial condition of an insurer and includes recommendations. - An approved auditor certifies that an insurer has adequate systems and procedures to ensure compliance with prudential standard requirements, statutory requirements, authorization conditions and any other conditions imposed by APRA. - A written Risk Management Strategy (RMS) must be approved by the Board and reviewed regularly. APRA requires annual Board declarations certifying that the insurer has complied with the RMS and the Reinsurance Management Strategy (REMS) and that both strategies are operating effectively in practice. - GPS 220 requires periodic internal audits with results reported promptly to the board or the board audit committee. An insurer is required to establish a board audit committee. - Outsourcing: - Currently covered under Guidance Note GGN 220.5 Operational Risk. - In May 2005, APRA released a draft Prudential Standard GPS 221 Outsourcing to strengthen requirements on due diligence, approval and ongoing monitoring of material outsourcing arrangements. ### Life insurance — Statutory funds, audit, actuary and governance - The establishment of statutory funds helps safeguard the investments and assets of policyholders and sets rules on eligible investments and expenditures. - Directors must take reasonable care and use due diligence to ensure the interests of policyholders are given priority. - It is mandatory to establish audit committees. - The appointed auditor and approved actuary shall bring to the attention of the directors any contravention of the LIA or any matter that may prejudice the interests of policyholders; failing to get the directors’ attention, they must take the matter to APRA in writing. - Auditors and actuaries have responsibility to satisfy themselves that the underlying data systems are adequate and accurate. - A draft standard on outsourcing is being developed. Internal audit function is covered under the draft standard on Governance. ### Assessment of governance and risk management - Assessment: Largely observed. - Comments: To clarify and strengthen existing requirements, APRA recently released additional proposals on governance and risk management, including a requirement for an internal audit function. ### Principle 11 — Market analysis (Ongoing supervision) - Description: - APRA conducts off-site analysis of the financial condition of individual entities and aggregate data to identify trends and industry norms. - Two industry groups (general insurance and life insurance) prepare industry-wide reviews. - A dedicated Research Unit undertakes applied research. - APRA is designing a more comprehensive semi-annual publication; currently Insight is published quarterly. - APRA uses Moody’s KMV, industry publications, market surveys, media releases, and government statistics in analysis. - Publicly available industry data sources include: - a) Insurance Council of Australia - quarterly briefing paper on general insurance; - b) the IAAust - bimonthly magazine, Actuary Australia, quarterly Australian Actuarial Journal and mortality and morbidity statistics; - c) Insurance Statistics Australia - management information relevant to pricing and profitability of selected classes of insurance business; - d) Insurance Reference Services – database with more than 18 million insurance claims dating back 10 years; - e) the Motor Accidents Authority - bulletins, information sheets, newsletters and regular comprehensive industry claims analysis on CTP insurance; - f) the Motor Accident Insurance Commission - a claims register and statistical database for participating insurers; and - g) the Australian Competition and Consumer Commission – studies into and findings on the insurance industry. - Under the Financial Sector (Collecting of Data) Act, 2001 (FSCD Act), APRA can determine reporting standards. Example: in July 2004 APRA determined that all APRA-regulated general insurers, and participating State and Territory Governments, shall contribute data to the National Claims and Policies Database for public and products liability and professional indemnity insurance; reports produced twice a year covering data from 2003 onwards. - APRA contributes to international bodies: IAIS, the IAA, the Joint Forum and the FSF. - General insurance publication: APRA’s Quarterly General Insurance Performance Statistics provides industry aggregate summaries. - Life insurance publications: Insight (quarterly), Life Insurance Trends (quarterly) and Life Office Market Report (six-monthly). - Assessment: Observed. ### Principle 12 — Reporting to supervisors and off-site monitoring - Description: - APRA requires, at licensing, a written undertaking that the licensed insurer will provide APRA with any information required for prudential supervision. - FSCD Act empowers APRA to direct entities to amend inadequate, incorrect, incomplete or misleading information; failure to comply is an offence. It is an offence under the Criminal Code to provide false or misleading information or documents to APRA. - Reporting requirements do not apply to state or territory insurers exempt from the LIA or IA; currently only one such exempt entity with insignificant operations. - APRA’s off-site surveillance includes checking returns regularly and conducting peer analysis to identify trends and anomalies. - Reporting methodologies and forms are regularly reviewed, including to give effect to the adoption of IFRS. - General insurance reporting specifics: - All licensed general insurers must comply with reporting requirements under the FSCD Act. APRA has determined 28 general insurance reporting standards. - Separate reports required for the licensed entity and the consolidated group where applicable. - Insurers generally follow Australian accounting standards for reporting periods before 1 January 2005; departures by APRA (e.g., valuation of premium liabilities, deferred reinsurance expenses and deferred acquisition costs) are specified. - General Insurance Reporting Form GRF 130 series collects off-balance sheet exposures. - Insurers must regularly provide APRA with: a) RMS; b) REMS; c) an annual Board Declaration pursuant to section 21 of GGN 220.2; and d) actuarial reports. - An approved auditor must submit an annual certificate to APRA confirming statistical and financial data reliability. A draft prudential standard GPS 310 Audit and Actuarial Reporting and Valuation is under consultation specifying certification include reference to compliance with the FSCD Act. - Amendments to GPS 220 propose annual submission of a Financial Information Declaration (FID), co-signed by CEO and CFO, stating that financial information lodged with APRA is accurate and complete and prepared in accordance with relevant Acts and standards. - Prompt notification to APRA required for: a) changes to Maximum Event Retention; b) amendments to RMS; c) if the right to conduct insurance business outside Australia is limited or materially affected; d) amendment to REMS; and e) within 24 hours of experiencing a major disruption that has the potential to materially impact policyholders. - Draft GPS 220 requires insurers to consult with APRA prior to implementing any changes that may materially affect risk profile. - Life insurance reporting specifics: - APRA has not issued reporting standards; reporting obligations (quarterly, half-yearly and annual) are set out in the LIA with formats/methods in Prudential Rules and Actuarial Standards. - APRA can request information, documents and records relating to the business of the life company and its subsidiaries; reporting requirements apply to all registered life companies. - Prudential Rule 35 Financial Statements requires compliance with Corporations Law, Accounting Standards (Australian and International) and actuarial standards; consolidated financial reports required where life company is parent in an economic entity. - Off-balance sheet exposures addressed in Form H (Prudential Rule 26). - A life company must provide APRA with the Financial Condition Report (FCR) by the appointed actuary within three months. - Assessment: Observed. ### Principle 13 — On-site inspection - Description: - APRA is empowered to conduct on-site inspections and conducts routine on-site prudential reviews without invoking legislative powers. - Supervisory cycle determined by PAIRS and SOARS; full prudential reviews vary between one and four years depending on PAIRS rating. - APRA may undertake additional prudential reviews or targeted investigations; may direct targeted investigations by an auditor or actuary chosen by APRA. - Prudential review modules cover key risk areas and assess adequacy of external audit and actuary functions. APRA may meet external auditor or appointed actuary during on-site process. - Closing meeting held after completion of prudential review; insurer must respond to final review report within 4 weeks, including timetables to implement proposed actions. Timelines are entered into AIMS for monitoring and tracking. - General insurance: - In consultation with an insurer, APRA may request the Approved auditor to undertake a specific review of a particular aspect. - Draft GPS 221 (May 2005) proposes giving APRA access to documentation related to outsourcing arrangements and right to conduct on-site visits to service providers; expected to take effect from 2006. - In practice, APRA has conducted on-site visits to service providers, joint venture partners and underwriting agencies of general insurers. - Life insurance: - APRA’s inspection powers under section 133 of the LIA extend to third parties such as intermediaries or persons providing outsourced services. A standard on outsourcing is being drafted. - Assessment: Observed. ### Principle 14 — Preventive and corrective measures - Description: - APRA maintains good rapport with regulated institutions; minor preventive or corrective actions are normally conveyed face-to-face. - Legislation provides APRA with many directions powers. APRA seeks voluntary remedial actions first and increases oversight where concerned with an entity’s risk profile, using off-site monitoring and risk-based on-site reviews supported by PAIRS, SOARS and ASF. - Serious cases are escalated to the Enforcement Unit. - General insurance — constraints and enforcement issues: - APRA’s authority to give directions and enforce powers is constrained by requirements, high thresholds and narrow triggers: - a) Conditions imposed on authorization must relate to prudential matters; - b) A direction under sections 49M and 49N requiring an insurer to make provisions in its accounts is subject to the Treasurer’s agreement; - c) To freeze insurer’s assets for up to six months, APRA must seek the Treasurer’s agreement; - d) APRA has experienced difficulties in enforcing powers when an insurer’s affairs are under investigation. - APRA has no power to apply for injunction under the IA to require insurers to refrain from actions such as issuing new policies. - APRA can accept enforceable undertakings under the IA; enforceable undertakings are voluntary and their effectiveness hinges on legal drafting and remain untested in courts. - Life insurance: - The LIA provides APRA with a range of powers: impose conditions on authorization at any time; determine standards; issue a wide range of directions; give written notices to remedy breaches relating to statutory funds; set solvency and capital adequacy standards for statutory funds and management capital outside statutory funds; with Treasurer’s approval give directions to increase capital levels; freeze assets up to 6 months subject to Treasurer’s approval; give directions during or after an investigation; apply for injunctions. - Directions requiring ministerial approval are exempt from merits review under section 236 of the LIA; can be given where a life insurer is, or likely to become, unable to meet policy or other liabilities as they become due. - APRA cannot accept an enforceable undertaking under the LIA. - Assessment: Observed for Life insurance and Largely Observed in General insurance. - Comments: APRA uses communication to achieve early detection and corrective action. APRA’s powers under the LIA are broader and less constrained than under the IA. ### Principle 15 — Enforcement or sanctions - Description: - Sanctions, offences and penalties are provided throughout the LIA and IA. Failure to comply with APRA directions is an offence under both Acts. - The Enforcement Unit handles problem entities; the Enforcement Committee sets priorities and review strategies. Cases are classified as Significant, Minor and No Further Action. - It is an offence to conceal, destroy, mutilate or alter a book relating to the affairs of an insurer under investigation. - APRA has standing to apply for winding-up under section 462 of the Corps Act where insurer has liabilities in excess of assets within the meaning of prudential standards. - General insurance enforcement tools and limitations: - With Treasurer’s approval, APRA can restrict an insurer from issuing new or renewing policies under section 62 of the IA when an investigation is underway. - APRA may direct assignment of liabilities to another general insurer where in the interests of policyholders and national interest; license can then be revoked. - GPS 110 enables APRA to adjust an insurer’s Minimum Capital Requirement where determined amount does not adequately reflect risk profile. - Guidance Note GGN 110.1 restricts an insurer’s ability to purchase its own shares without APRA approval. - While APRA can direct removal of directors or senior managers if they are disqualified or unfit, such disqualification decisions are subject to review by the AAT and have proven time-consuming and costly. - APRA lacks power to appoint an administrator or statutory manager for general insurers. - Division 3 of the IA details procedures for compulsory transfer of business for insurers unlikely to remain solvent; Treasurer’s approval required before APRA revokes authority. - APRA has used disqualification powers, enforceable undertakings, powers to impose conditions, and increased investigations since 2002 reforms. - Life insurance enforcement tools: - APRA may direct a life company not to issue any policy, collect premiums or discharge liabilities where doing so may prejudice policy owners. - With Treasurer’s agreement, APRA may direct a life company not to issue further policies under section 150 of the LIA if under investigation and unable or likely unable to meet liabilities or has contravened the LIA or a direction. - APRA may apply to the Court for judicial management, winding-up, or compulsory transfer determination under the FSTB Act. - LIA enables APRA to give solvency and capital adequacy directions and directions under section 230B (e.g., not to repay amounts on shares, not to dividend, not to transfer assets of a statutory fund). - APRA can investigate companies associated with the insurer and issue directions regarding ownership or dealings with associated companies. - APRA may direct removal or replacement of directors, secretaries, executive officers or employees, and directors may be liable to compensate the insurer for breaches of duties under the Act. - APRA may revoke approval of an auditor or actuary for inadequate performance. - Proceedings to initiate judicial management or winding-up are not hindered by prosecutions under the LIA. - All life insurers (except “eligible foreign life insurance companies”) operate as subsidiaries in Australia and statutory funds ring-fence assets to protect policyholders. - Assessment: - Observed for life insurance and Partly Observed for general insurance. - Comments: - General insurance: APRA’s enforcement powers are constrained in practice; legal processes (e.g., AAT reviews) can be time-consuming. APRA cannot appoint administrators and may be hindered by insurers’ voluntary appointments of administrators and Deeds of Company Arrangement. - APRA’s ability to prove insolvency under prudential standards is challenged by actuarial uncertainty and assumptions. - These limitations may render APRA’s enforcement and sanctions insufficient to compel compliance or deal with emergencies. - Life insurance: APRA’s wide-ranging directions powers can stop a life insurer from carrying on business and court remedies (winding-up, compulsory transfer) are available. ### Principle 16 — Winding-up and exit from the market - Description: - General insurance: - APRA may revoke an insurer’s authorization in certain circumstances with the Treasurer’s agreement. - APRA may direct assignment of liabilities to another authorized insurer, subject to Treasurer’s approval, but has yet to test these powers. - Enforceable undertakings have been used to manage insurer exit (e.g., undertakings to cease underwriting new business or specified lines). - Division 3 of the IA details procedures for insurers unlikely to continue solvent but for whom a compulsory transfer of business is reasonably prospectable. - Where an insurer is, or is likely to become unable to meet debts as they fall due, it may be wound up under the Corps Act. - Assessment: (Implicit in prior sections) APRA has legal options for orderly exit but practical and legal constraints affect timeliness and effectiveness of some measures. *Source: _cr06415 - Section 912A of the Corps Act also imposes obligations on directors of entities that hold AFSLs* ### Section 17 of the IA requires that the interests of policyholders are considered in ### Section 17 of the IA requires that the interests of policyholders are considered in ### Policyholder protection and winding-up (general insurance) - Section 17 of the IA requires that the interests of policyholders are considered when an insurer’s liabilities are assigned to one or more other general insurers. - Policyholders and other policy beneficiaries do not have priority of claims in the event of an insurer becoming insolvent. - There is no restriction on encumbrance of insurers’ assets other than higher capital charges. - In the winding-up, a general insurer’s assets in Australia must not be applied in the discharge of its liabilities other than its liabilities in Australia unless it has no liabilities in Australia. - Policyholders’ claims would still rank equally with other creditors in winding-up. - No restriction on encumbrance of assets provided the general insurer provides for higher capital charge. ### Life insurance — powers and winding-up - The LIA provides for a range of options to halt the business of a life insurer. - APRA may freeze the assets of an insolvent insurer. - If a life insurer has contravened the LIA, APRA may: - issue directions; or - apply for an injunction prohibiting issuing any policy, collecting any premium or discharging any policy or other liability. - APRA or the life insurer can apply to the Federal Court for the insurer to be placed under judicial management. - An insurer may not issue policies without the leave of the Court when it is under judicial management. - Division 2 of Part 8 of the LIA contains winding-up provisions that provide material protection for policy owners: - Assets of a statutory fund must first be applied to discharge debts and claims referred to in section 556(1) of the Corps Act including relevant expenses, administrator debts, wind-up costs, staff wages and injury compensations. - Thereafter, preference is given to discharging policy liabilities of the statutory fund. - Other liabilities referable to the business of the statutory fund are not to be met out of the assets of the fund unless all policy owner liabilities have first been discharged. - Uncertainty: the priority of claim of a policyholder of a statutory fund in deficit is unclear where one fund has a surplus while another has a deficit. ### Assessment of compliance (Section 17) - Assessment: Observed for life insurance and partly observed for general insurance. - Comments: - Domestication of a general insurer’s assets in Australia contributes to policyholder protection but does not give policyholders priority above other unsecured creditors in winding up. - APRA currently lacks the ability to appoint an administrator to manage the affairs of a general insurer to protect policyholders and other beneficiaries. - The LIA provides a high degree of protection for policy owners in insolvency: - Prohibits issuing of policies while a company is under judicial management. - Judicial manager or APRA can apply for an order that the life insurer be wound up. - Policy owners receive priority ahead of other creditors other than expenses connected with winding-up and employee payments (wages, injury compensation, redundancy). - Remaining issue: priority of claim where one statutory fund has surplus and another deficit is unclear. ### Principle 17 — Group-wide supervision (description & findings) - Principle: The supervisory authority supervises its insurers on a solo and a group-wide basis. - General insurance: - Current regime focuses largely on individual authorized insurers; no consolidated supervision. - No explicit requirement regarding insurance activities conducted by subsidiaries and associated companies in overseas jurisdictions. - A discussion paper on Prudential supervision of corporate groups involving authorised general insurers was released for public consultation in May 2005. - The IA allows APRA to authorize, and impose reporting obligations on NOHC. - Life insurance: - No formal supervision of the group under the LIA. - Development of a similar framework to regulate NOHC is on APRA’s agenda. - Supervisory regime based on statutory fund concept: ring-fencing assets backing policy liabilities in a statutory fund. - Stringent rules on investment and management of statutory fund assets; actuarial standards for solvency and capital adequacy; insurer’s equity investment in regulated subsidiaries treated as inadmissible assets. - An insurer must not invest assets of a statutory fund in a related company that is not a subsidiary without APRA approval; all investments in subsidiary and related companies must be reported to APRA. - APRA receives information on a group basis; proposed consolidated supervisory framework includes provision for effective group systems and controls to ensure availability and reliability of group statistical and financial data. - Assessment: Largely Observed. - Comments: - Framework for consolidated supervision is in progress; all financial groups in Australia are under APRA supervision as integrated prudential supervisor. - Life companies owned by banks account for over 50% of life company assets in Australia. - Almost 90% of life company assets relate to superannuation subject to the Superannuation Industry (Supervision) Act 1993, also administered by APRA. - APRA has adequate powers to restrain insurers from group operations that may prejudice policyholders. ### Principle 18 — Risk assessment and management - Principle: Supervisory authority requires insurers to recognize and manage the range of risks they face. - APRA follows a systems-based approach; Board and senior management bear primary responsibility; risk management frameworks assessed in on-site prudential reviews. Only mandated Board committee currently is an Audit Committee. - General insurance: - GPS 220 Risk Management for General Insurers requires Board and senior management to develop, implement and maintain a sound and prudent RMS. - An insurer’s RMS must be submitted to APRA within 14 days of being approved by the Board. - RMS must be appropriate to size, business mix and complexity; define objectives and strategy for risk management and internal control. - Minimum risk categories to be addressed: a) balance sheet and market risk (including investment risk, insurance risk, product design and pricing risk, underwriting and liability risk, liquidity risk, risk arising from claims management and derivatives risk); b) credit risk; c) operational risk (including legal and reputational risks). - RMS should account for potential risks from reinsurance arrangements. - RMS must be reviewed regularly and amended as needed. - Stage 2 Reforms envisage an enterprise-wide framework and increased disclosure. - Life insurance: - No explicit prudential standard on risk management. - For solvency and capital determination, risk identification and assessment capabilities are required. - Through the FCR, APRA is informed of adequacy and effectiveness of an insurer’s risk management policies and procedures. - Superannuation licensing under SIS Act requires a risk management plan for the RSE. - Actuarial standards address a wide range of liability and asset risks and prescribe a resilience reserve in solvency and capital adequacy computations. - Assessment: Observed for general insurance and Largely Observed for life insurance. - Comments: - APRA has established risk management standards for general insurance and is fine-tuning through Stage 2 Reforms. - For life insurers, risk management is an implicit requirement via actuarial standards and appointed actuary reporting in the FCR. - APRA plans to issue prudential standards on risk management under the LIA consistent with IA arrangements. ### Principle 19 — Insurance activity (underwriting, reinsurance, pricing) - Principle: Insurers must evaluate and manage underwriting risks and have tools to establish adequate premiums. - APRA’s on-site prudential review program includes Module 10 Insurance Risk focusing on product development, pricing, underwriting, claims, administration, reinsurance and distribution. - Module 10 checks include monitoring of portfolio performance via average premium, rate movement, underlying claims costs, frequency vs severity of claims, and data quality. - APRA verifies methodology for establishing net retention and reinsurance structure to ensure adequate cover for estimated probable maximum loss (PML). - APRA specialist teams: - Insurance Risk team (mandatory participation for Module 10 reviews of high and extreme impact insurers). - Actuarial Services team provides actuarial advice on FCRs and liability valuation. - General insurance: - GPS 220 requires both RMS and REMS. - Annual Board Declaration required confirming compliance and reinsurance arrangements. - Stage 2 Reforms propose strengthened oversight of reinsurance management including an annual Reinsurance Arrangements Statement and a two-stage documentation declaration process (two months and six months after reinsurance arrangements take effect) signed by CEO and Chief Reinsurance Officer (or equivalents). - Reinsurance failing the two- and six-month documentation tests will not be taken into account for capital adequacy calculations. - Proposed GGN 230.3 Limited Risk Transfer Arrangements: insurers must seek APRA approval before limited risk transfer arrangements. - Draft GPS 310 requires approved actuary to assess overall financial condition annually and prepare an FCR listing any limited risk transfer products with comments on extent of risk transfer. - Life insurance: - Appointed actuary must produce written report before issuing new policy types advising on terms, surrender value basis, and unit value determination; reinsurance subject to appointed actuary advice. - Board must take the appointed actuary’s advice into account. - FCR is used to assure that life company monitors expenses appropriately; expense assessment is a top priority for appointed actuary. - Every life company must give APRA an annual reinsurance report as prescribed by Prudential Rule 23. - Assessment: Observed. - Comments: APRA monitors insurance risks through on-site and off-site analysis; in-house Insurance Risk and Actuarial Services teams provide specialist expertise. ### Principle 20 — Liabilities (technical provisions and reinsurance recoverables) - Principle: Supervisory authority requires adequate technical provisions and allowance for reinsurance recoverables, and can require increases. - APRA empowered to direct insurers to increase technical provisions, subject to Treasurer’s approval. - Insurers expected to undertake stress testing as part of business planning; large general insurers undertake regular scenario analysis voluntarily. - General insurance: - GPS 210 Liability Valuation for General Insurers establishes principles for consistent measurement and reporting of insurance liabilities. - Approved actuary must provide written advice to the Board at least annually on value of insurance liabilities per the prudential standard. - Actuaries must follow IAAust Professional Standard 300 and Guidance Note 353 in preparing estimates of technical liabilities. - Insurance liabilities defined to include Outstanding Claims Liabilities (OCL) and Premiums Liabilities for each class. - Value of insurance liabilities is the sum of: a) the central estimate value of the OCL; b) the central estimate value of the Premiums Liabilities; and c) risk margins relating to inherent uncertainty. - The risk margin is intended to secure insurance liabilities of the insurer at 75% of sufficiency. - Risk margin should not be less than one half of the coefficient of variation for the insurance liabilities. - Risk diversification and reinsurance across classes may reduce risk margins for each class. - Reinsurance recoveries estimated using same principles as gross liability valuation; approved actuary’s Liability Valuation Report must consider reinsurance recoveries. - Risk that recoveries will not be received is part of investment risk; additional capital charge for concentration may apply where aggregate exposures to a particular reinsurer exceed set threshold. - Stage 2 Reforms propose stricter rules to monitor reinsurance arrangements. - General insurers using Internal Model Based Method for MCR must have comprehensive stress testing; so far, no insurer has applied to use the Internal Model Based Method. - Insurers using APRA prescribed methodology to determine MCR must calculate a Maximum Event Retention (MER). - Life insurance: - Valuation of policy liabilities referable to a statutory fund must follow actuarial standards. - The LIA establishes the LIASB to make actuarial standards; LIASB promulgated Actuarial Standard 1.03 Valuation of Policy Liabilities. - Actuarial Standard 1.03 defines “Policy Liability” as the sum of the Best Estimate Liability and the value of expected future profits. - Policy liability must provide for best estimate value and uniform emergence of profit relative to appropriate Profit Carriers; all relevant expenses must be allocated into acquisition, maintenance and investment management and into related product groups. - Treatment of reinsurance is specified; policy liability gross of reinsurance required to be disclosed as sum of net policy liability and reinsured policy liability. - Rules for recognition of reinsurance for solvency and capital adequacy are stipulated in actuarial standards. - Assessment: Observed. - Comments: - APRA has prudential principles for best estimate valuation of general insurance liabilities with a 75 percent margin of sufficiency. - Life policy liabilities are determined based on actuarial standards that provide for best estimate liability and uniform emergence of profit. ### Principle 21 — Investments - Principle: Supervisory authority requires standards on investment activities including policy, asset mix, valuation, diversification, asset-liability matching, and risk management. - Assets and investment risks covered in APRA prudential reviews; consistent with IFRS, AASB requires insurer assets measured at fair value. - General insurance: - APRA requires a general insurer to address investment risk in its RMS as part of balance sheet and market risk management. - GGN 220.3 defines investment risk to include market risk, credit risk, investment concentration risk and asset and liability mismatch risk. - Stage 2 Reform proposes enhanced management of investment risk. - Approved actuary to prepare annual FCR assessing insurer’s approach to asset and liability management and comment on issues given liability profile and liquidity needs. - Life insurance: - Safeguarding assets backing policy liabilities achieved through statutory funds. - Part 4 of the LIA provides for investment, administration and management of statutory fund assets; prohibits encumbrance of any assets of a statutory fund; controls movement of assets in and out of statutory fund and defines restricted investments. - Directors breaching duties causing loss to a statutory fund liable under sections 48 and 50 of the LIA. - Prudential Rule 35 requires a Directors’ declaration attached to annual financial statements specifying whether statutory fund assets have been applied or invested contrary to the LIA. - Statutory funds subject to solvency and capital adequacy requirements addressing asset risks: a) adverse market movements; b) assets realization; c) holdings in associated entities; d) asset concentration; e) credit risks; f) liquidity risks. - Additional reserve required for changes in value of assets in a run-off situation. - Appointed actuary must consider credit and liquidity risks and overall asset risks in assessing solvency and capital adequacy; must assess resilience and provide for a resilience reserve including asset-liability mismatch considerations. - Professional Standard 200 guides actuaries on data veracity, derivatives, mismatching and default risks, suitability to liabilities and admissible assets; actuary checks investment policy impacts on future returns and suitability to liabilities. - Advanced criteria: - Proposed RMS amendments require modeling and stress-testing of current and alternative investment strategies on financial outcomes and asset-liability mismatch for general insurers. - Resilience reserve for life insurers ensures statutory fund can sustain economic shocks. - Assessment: Observed for general insurance and Largely Observed for life insurance. - Comments: - APRA requires general insurers to address investment risk in RMS. - No explicit investment rule for life insurance beyond statutory funds; Part 4 LIA stipulates restricted investments and prohibits encumbrance. - Actuarial standards address asset risks and encourage diversification and minimizing asset/liability mismatches. - Nearly 90 percent of life company assets are investment linked superannuation assets subject to investment mandate. - APRA plans comprehensive prudential standards on risk management under the LIA consistent with standards proposed for general insurers. ### Principle 22 — Derivatives and similar commitments - Principle: Supervisory authority requires standards on use of derivatives, including restrictions, disclosure, internal controls and monitoring. - General insurance: - A circular on derivatives in place since 1995. - GGN 110.4 Investment Risk Capital Charge requires insurers to set aside capital to cover investment risk from derivative contracts. - For limited derivative usage, a prescribed method for computing capital charge exists; for significant derivative transactions APRA may prescribe a method to calculate additional capital charge. - GGN 220.3 stipulates minimum requirements for derivatives control. - Information on derivatives collected via forms including GRF 140.1, GRF 140.4, GRF 310.3, and GRF 160.0 Derivative Activity and Risk Charge. - Life insurance: - Circular No C.I.1 (1995) regulates use, management and control of derivatives (lacks formal legal standing but effective). - Life insurers using derivatives must have satisfactory risk management practices for derivatives evidenced by a RMS. - Use of the following derivative types should generally be restricted: - a) highly leveraged derivatives; - b) uncovered derivatives; - c) derivatives where potential for losses is considerably higher than the initial investment or is unlimited; - d) derivatives where potential exposure cannot be reliably measured; - e) derivatives where closing out is difficult considering market illiquidity; - f) derivatives where the underlying asset is not admissible for solvency purposes. - Assessment: Observed. - Comments: - APRA has long history of monitoring insurers’ derivatives involvement; circulars have been effective. - APRA has an in-house Balance Sheet and Market Risk Team that monitors market developments and provides specialist advice to frontline supervisors. ### Principle 23 — Capital adequacy and solvency - Principle: Supervisory authority requires insurers to comply with prescribed solvency regime including capital adequacy and suitable capital forms to absorb significant unforeseen losses. - APRA supervises many conglomerate groups including insurers; some groups subject to banking prudential requirements which require capital investments in insurers be deducted from bank capital base at standalone and consolidated levels. - APRA maintains international policy engagement via IAIS and IAS; close relationships with UK and Canada. - General insurance: - Prudential Standard GPS 110 Capital Adequacy for General Insurers and guidance notes set out the MCR. - Two options to determine MCR: Internal Models Based Method or a Prescribed Method. - Both methods must provide capital charges for: a) insurance risk; b) investment risk; c) concentration risk. - MCR computation allows different risk capital factors by business class, asset type, counterparty grading and concentration. - Policy intention: MCR established at an overall sufficiency level of 99.5%. - The minimum MCR coverage is 1.2 times. - Stage 2 Reforms require RMS to include strategies for holding capital reserves above the MCR and processes/controls to monitor continuous compliance with MCR including trigger ratios. - A general insurer must at all times have capital in excess of its MCR. - Eligibility criteria and conditions on capital eligible to meet MCR prescribed in GGN 110.1 Measurement of Capital. - Tier 1/core capital comprises proceeds from instruments permanent and non-cumulative; Tier 2 includes hybrid capital instruments. At least 50 per cent of an insurer’s capital base must be in Tier 1 instruments. - REMS must include policies and procedures for selection of reinsurance counterparties. - Investment risk capital charge designed to cover risk of counterparty default including exposures to a particular reinsurer exceeding set thresholds. - Proposed GGN 230.3 to require APRA approval for limited risk transfer arrangements and specify capital treatment. - GPS 210 requires risk margin and MCR must include a MER for catastrophic losses. - GPS 110 requires foreign-incorporated insurers operating branches in Australia to maintain assets in Australia in excess of their liabilities in Australia at least equal to the MCR. - General insurers using Internal Model Based Method must have comprehensive stress testing; so far no insurer has applied for Internal Model Based Method. - APRA has not stipulated stress testing for those using prescribed methodology though large general insurers undertake scenario analysis. - MER considerations: a) relevant areas of risk concentration; b) perils producing greatest MER; c) return period of relevant catastrophes and MER sensitivity; d) modeling of insurer’s past experience; e) appropriate external commercial data and modeling. - Life insurance: - Solvency determined on basis each statutory fund has sufficient assets to fund existing liabilities if fund wound up; designed to require reserves to a broad target level of safety of 99.5 percent. - Capital adequacy requirement determined on a going concern basis; generally higher than solvency requirement and act as early warning trigger. - Policy intention for insurers to hold reserves at a safety level of 99.75 percent—broadly equivalent to S&P A rating. - APRA encourages life companies to hold assets in excess of regulatory requirements; insurers should have a target surplus policy commensurate with overall risk profile; APRA expects discussion of target surplus by appointed actuary in the FCR. - Actuarial standards 1.03, 2.03 and 3.03 establish valuation, solvency and capital adequacy principles and methodologies. - Solvency requirement broadly comprises solvency liability, other liabilities, an expense reserve, a resilience reserve and an inadmissible assets reserve. - Capital adequacy requirement comprises capital adequacy liability, other liabilities, a resilience reserve, an inadmissible assets reserve and a new business reserve. - Asset risks addressed through inadmissible asset reserve or other additional reserves; resilience reserve deals with asset-liability matching. - With solvency and capital requirements met by excess of assets over liabilities in a statutory fund, there is no definition of eligible capital; attributes of capital (permanency and loss absorption) are reflected in treatment of assets; assets lacking attributes treated as inadmissible under AS2.03 and AS3.03. - APRA has determined a Management Capital standard to ensure life companies adequately capitalized outside statutory funds. - A life company must hold sufficient assets in the General Fund per Actuarial Standard 6.02 Management Capital Standard. - Insurers required to hold the higher of management capital under Actuarial Standard 6.02 or the minimum A$10 m under Prudential Standard No 3, Prudential Capital Requirement outside the statutory funds. - For companies limited by shares only, prudential capital must take the form of ordinary shares, irredeemable preference shares or APRA approved redeemable preference shares. - For a life company limited both by shares and guarantee or without share capital, capital must be held in form of eligible assets as defined in prudential standard. - Assessment and comments (capital & solvency): - Detailed requirements for MCR, MER and risk margins for general insurers; capital policy intentions of 99.5% sufficiency for MCR and 99.75% target safety for life insurers. - Allowance for reinsurance is subject to reinsurance arrangements meeting specified criteria. *Source: IMF staff report content (excerpt) contained in the provided PDF.* ### section 3.3 of AS2.03 and AS3.03. Where the reinsurance arrangements are with “ineligible” ### section 3.3 of AS2.03 and AS3.03. Where the reinsurance arrangements are with “ineligible” ### Reinsurance and policy liabilities - Where the reinsurance arrangements are with “ineligible” reinsurers, the arrangements are to be ignored when calculating the liabilities in respect of the policies. ### Solvency and capital adequacy for life and general insurers - Solvency and capital adequacy requirements are risk-based; the level of requirements depends on the size and nature of the life company’s operations. - Both the solvency and capital adequacy requirements include a resilience reserve. - The appointed actuary must undertake capital projections that consider how the value of a life company’s assets and liabilities would be affected by adverse scenarios to accurately assess resilience requirements. - Both regimes address the risk of double gearing of capital of associated entities. - Holdings in an associated entity which is an institution itself subject to legislated minimum capital requirements are treated as inadmissible assets under the solvency and capital adequacy standards. - Eligible foreign life insurance companies operating as branches will be required to operate their Australian business in a separate statutory fund subject to solvency and capital adequacy regimes. ### Assessment and supervisory comments on capital regimes - Assessment: Observed - Comments: - The capital adequacy regime in place for general insurance is prudent and comprehensive. - Although it does not currently apply at a group level, legislative provisions are already in place. - The solvency and capital adequacy regimes for life insurance have worked well. - Capital instruments do not have a large role given the statutory fund structure. - APRA plans to harmonize the capital regime of life companies with that of banks and general insurers. ### Principle 24 — Intermediaries: licensing, competence and conduct - Description: - Insurance intermediaries are required to hold an AFSL under the Corps Act, except when acting as an authorized representative of an AFSL holder or an exemption applies. - Insurance contracts fit the definition of “financial services business” including providing “financial product advice” and dealing in “a financial product”. - As a principal, an insurance broker or financial services business giving advice on an insurance product must hold its own AFSL; authorized representatives are exempt. - AFSL applicant obligations: - a) ensure financial services covered by the AFSL are provided efficiently, honestly and fairly; - b) maintain the competence to provide the financial service; - c) comply with financial services laws; - d) ensure the AFSL holder's representatives are adequately trained and competent. - Regulatory guidance: - ASIC Policy Statement PS 164 Licensing: Organisational Capacities provides guidance on competence of senior management. - Training requirements specified in Policy Statement PS 146 Licensing: Training of Financial Product Adviser, including minimum training standards for advice to retail clients. - Character and enforcement: - Section 913B of the Corps Act requires the AFSL holder to be of good fame and character; no such statutory requirement for an authorized representative (onus on AFSL holder). - ASIC can suspend or cancel AFSL, make banning orders, impose/vary conditions. If AFSL holder is an insurer regulated by APRA, ASIC must first consult APRA before making changes to the insurer’s AFSL; ASIC must advise APRA of action within a week even when consultation is not required. - Client money and trust accounts: - An intermediary who is an AFSL holder must pay client money into an account with an APRA authorized deposit-taking institution, an approved foreign bank, or a cash management account; account can only be used for client money. - No requirement to maintain separate accounts for each client; a single account for all clients is permitted. - Money paid by the client is taken to be held on trust for the client; if AFSL holder becomes insolvent, client money remains property of clients and cannot be used to pay the AFSL holder's creditors. - Disclosure and penalties: - The Corps Act requires provision of a Financial Services Guide (FSG) to assist retail clients. - Intermediaries are required to disclose fees and commissions charged. - ASIC may take enforcement action against anyone carrying on a financial services business without an AFSL. Penalty for failure to hold AFSL: $220,000 or 2 years imprisonment or both. - Assessment: Observed - Comments: ASIC has issued policy statements regulating professional conduct of intermediaries; intermediaries required to maintain separate trust accounts for clients’ monies. ### Principle 25 — Consumer protection - Description: - To be licensed, an AFSL holder must “do all things necessary to ensure that the financial services covered by the AFSL are provided efficiently, honestly and fairly” and “maintain the competence to provide those financial services”. - ASIC can suspend or cancel an AFSL if the AFSL holder cannot meet license requirements on an on-going basis. - ASIC has approved the ICA’s General Insurance Code of Practice and the independent complaints resolution scheme, Insurance Enquiries and Complaints Ltd. - The Insurance Contracts Act 1984 imposes a duty on insurers to act with the utmost good faith and contains provisions preventing insurers from denying claims where denial would be unfair on the consumer. - Advice standards and disclosure: - An AFSL holder and an authorized representative must have a reasonable basis for “personal advice” to a “retail client”; determine relevant personal circumstances. - For “general advice”, notify the client that advice was prepared without taking account of the client's specific objectives, financial situation or needs. - Clients should obtain a Product Disclosure Statement (PDS) when advice relates to acquisition of a particular financial product. - Part 7.7 of the Corps Act contains financial services disclosure requirements: FSG; Statement of Advice (SOA); and PDS including significant benefits and risks and dispute resolution information. - Dispute resolution: - Corps Act requires AFSL holders to have internal dispute resolution and membership of one or more external dispute resolution schemes. - ASIC Policy Statement PS165 stipulates internal dispute resolution procedures must satisfy Essential Elements of Effective Complaints Handling in Australian Standard AS 4269 1995. - External dispute resolution schemes must address accessibility, independence, fairness, accountability, efficiency and effectiveness. - The Insurance Ombudsman Service is a national service assisting in disputes and administers the industry Code of Practice. - Consumer information and education: - ASIC's website publishes licensed AFSL holders and lists banned or disqualified persons. - ASIC publications include Consumers and Money, Your Money, Don’t kiss your money goodbye, and You can complain. - ASIC developed a Consumer Education Strategy focused in part on schools. - Surveillance activity: - Since inception of the Financial Services Reform Act in 2002, ASIC has conducted 483 surveillances into insurers holding AFSL and/or their authorized representatives or Insurance brokers. Most surveillances were conducted in 2004/5. - Surveillance projects included insurance broker remuneration arrangements, regional surveillance, superannuation switching surveillance project and shadow shopping project. - Assessment: Observed - Comments: ASIC requires and monitors AFSL holders and representatives to conduct with due care and diligence and ensure fair treatment; industry has codes of practice, independent complaints resolution scheme and Insurance Ombudsman Service; ASIC website provides extensive consumer information and ASIC has a Consumer Education Strategy. ### Principle 26 — Information, disclosure & transparency - Description: - Policy owners have the right to receive the financial statements and annual returns given by a life insurer to APRA. APRA maintains a register of returns for individual life insurers for public inspection. - APRA requires extensive reporting from general insurers but currently only publishes a limited amount of this data and only at an aggregate level. - APRA is reviewing its disclosure regime with a view to expanding published information to facilitate assessment of financial strength of individual insurers by stakeholders. - Work is advanced on a new annual publication containing company specific general insurance statistics disclosing key profit and loss, balance sheet and solvency data at an individual insurer level. Consultation with industry is pending. - A person is entitled to inspect and obtain a copy or extract of certain public documents lodged with ASIC, including financial reports and directors’ reports. Periodic reports lodged pursuant to AFSL holder obligations or other Corps Act obligations are accessible by the public. ASIC has appointed information brokers to provide copies on behalf of ASIC. - Assessment: Observed - Comments: Both APRA and ASIC published extensive market data and analysis; selected regulatory information is easily accessible by the public through agencies’ websites or public inspection of documents. ### Principle 27 — Fraud prevention, detection and remedy - Description: - The ASIC Act, the Corps Act, and the Insurance Contracts Act (IC Act) are principal legislation addressing insurer fraud, administered and enforced by ASIC. - ASIC has investigative powers to deter, detect, record, report and remedy fraud in insurance, with civil and criminal remedies including injunctive powers, ability to freeze assets and ability to wind-up companies or managed investment schemes. - Where fraud is established, ASIC may apply to Court for declaration of breach of civil penalty provisions, apply for a civil penalty order, seek compensation for damages and seek orders to ban persons who have committed fraud. - ASIC enforcement outcomes (2003-04): - jailed 28 criminals - obtained 118 civil orders against people or companies - banned 22 people from directing companies - banned 42 people from offering financial services - disciplined or deregistered 13 company auditors and liquidators for misconduct - Remedies under Insurance Contracts Act: - Breaches involving general or life insurance may be punished through avoidance of insurance contracts; restitution if it only relates to general insurance; or varying the contract if the fraud relates to life insurance. - For fraud related to misstatement of age, insurer may apply to vary the contract by substituting or decreasing the amount payable according to the relevant formula in the Insurance Contracts Act. - Criminal prosecution: - There is no specific crime of insurance fraud in Australia; alleged fraud may be charged under provisions of the Crimes Act 1900 (NSW) and equivalent state provisions, including fraudulent misappropriation, obtaining money by deception and obtaining money by false and misleading statements. - Reporting and training: - There is no explicit requirement for insurers and intermediaries to promptly report fraud to the appropriate authorities. - AFSL holders are required to report to ASIC significant breaches or likely breaches of their obligations within 5 days; ASIC expects licensees to report fraud incidents under this obligation. - Counter fraud training requirement is implied in statutory requirement that an AFSL holder maintain competence to provide financial services. - APRA checks adequacy of staff training and awareness in fraud during prudential reviews of insurers. *Source: section 3.3 of AS2.03 and AS3.03. Where the reinsurance arrangements are with “ineligible” (extracted from the provided PDF content).* ### Section 915F of the Corps Act requires ASIC to publish a notice of suspension, revocation of ### _cr06415 - Section 915F of the Corps Act requires ASIC to publish a notice of suspension, revocation of ### ASIC registers, bans, and publication requirements - Section 915F of the Corps Act requires ASIC to publish a notice of suspension, revocation of suspension or cancellation of an AFSL in the Gazette. - Section 920E sets out an equivalent obligation on ASIC in respect of an authorized representative of an AFS licensee. - Section 920E(2) provides that the notice must also set out a copy of the banning order. - ASIC maintains a register of persons against whom a banning order or disqualification order is made. - ASIC maintains an Enforceable Undertaking Register which includes details of persons that have undertaken not to take part in the management of a corporation, or carry on a financial services business. - These registers do not include persons who have committed fraud but are not AFSL holders or their representatives. ### Fraud mitigation, industry engagement, and reporting - ASIC supported insurance companies in mitigating electronic fraud (internet) and promoted fraud reporting as part of “critical infrastructure” defensive mechanisms addressing risks such as rampant electronic crime reducing investors’ confidence in the financial system. - Under this initiative, ASIC brought the Insurance Council of Australia and a number of large insurers together to discuss ways to mitigate risks, particularly in relation to fraud. - Assessment: Observed. - Comments: The current regulatory measures to address insurance fraud could be enhanced by clarifying the reporting requirements in respect of insurance fraud and promoting more regular exchange of information on fraud amongst insurers. ### International cooperation and mutual assistance - ASIC can cooperate with foreign supervisory authorities through compulsorily obtaining and transmitting information, documents or evidence to a foreign regulator for the administration and enforcement of a foreign business law under the Mutual Assistance in Business Regulation Act 1992. - For proceedings in relation to a criminal matter or in respect of a foreign serious offence, ASIC can cooperate with foreign supervisory authorities under the Mutual Assistance in a Criminal Matter Act 1987. ### AML/CFT — Principle 28: framework, supervision, and information sharing - The supervisory authority requires insurers and intermediaries, at a minimum those insurers and intermediaries offering life insurance products or other investment related insurance, to take effective measures to deter, detect and report money laundering and the financing of terrorism consistent with the Recommendations of the Financial Action Task Force on Money Laundering (FATF). - The Financial Transaction Reports Act 1988 (FTR Act) and the Financial Transaction Reports Regulations 1990 are largely compliant with the FATF’s 40 Recommendations (1996 version). - The FTR Act imposes reporting, customer due diligence and document retention provisions on the broader cash dealer community. The term cash dealer includes insurers or insurance intermediaries. - AUSTRAC supervises insurers and intermediaries only in relation to their obligations under the FTR Act and is the financial intelligence unit (FIU) responsible for administering the FTR Act. - Part IVA of the FTR Act provides AUSTRAC with powers of inspection. - AUSTRAC has no role in supervising ownership or control of insurers or insurance intermediaries. - A draft exposure Bill was under preparation to bring Australia’s AML/CFT regime in line with the latest FATF recommendations; it will address customer verification and ongoing due diligence requirements, suspicious and other threshold transaction reporting obligations, recordkeeping and other requirements relevant to the financial sector. - APRA may disclose protected information to AUSTRAC, the Australian Federal Police, the Police Force of a State or Territory, the Australian Crime Commission and the Australian Treasury, among others. - AUSTRAC currently has 43 exchange agreements allowing it to share financial intelligence with other FIUs. - AUSTRAC maintains partner agency agreements with a broad range of law enforcement, national security, revenue collection and social justice agencies which enable the exchange of financial intelligence. - AUSTRAC is currently unable to share suspicious transaction information with APRA. - Current customer due diligence requirements are limited to identification verification of signatories of products considered to be accounts for the purposes of the FTR Act and generally occur when an account is opened and where a cash transaction involving $A 10,000 or more occurs. - The insurance industry does not normally deal in cash transactions. - Insurers and insurance intermediaries are required to report significant cash transactions ($A 10,000 or more), all international funds transfer instructions and suspicious transactions under the FTR Act. - FATF’s October 2005 Mutual Evaluation Report on Australia documented shortcomings in the legal framework and “did not find the implementation of the AML/CFT supervisory system to be effective in terms of the standards required by the revised 40 Recommendations.” It noted a need for enhanced coordination of AML/CFT measures among the relevant authorities. - Assessment: Partly observed. - Comments: Australia is committed to implementing a robust AML/CFT regime in line with FATF standards and is in the process of updating its legislative framework. ### Recommended action highlights (from Table 6) - Supervisory System (ICP2, 3, 4 and 5) - Ensure policy inputs from ASIC are addressed appropriately and in a timely manner given ASIC’s lack of policymaking powers. - Clearly spell out circumstances under which the Treasurer may give directions to APRA. - Consider public disclosure of reasons for removal of APRA Members and APRA consultation/notification of ASIC on insurer license actions where appropriate. - Supervised Entities (ICP6, 7, 8, 9 and 10) - Implement recommendations of the Potts Review on regulatory status and scope for DOFIs and DMFs, as appropriate. - Consider reviewing the requirement that APRA can only refuse registration of a life insurer with the approval of the Treasurer. - Give APRA explicit powers for cross-border supervision of insurance activities carried out by subsidiaries of insurers domiciled in Australia. - Ongoing Supervision (ICP11–17) - Empower APRA to deal with troubled institutions in a timely and cost-effective manner and consider harmonizing APRA powers across banking, life insurance and general insurance. - Markets and Consumers (ICP24, 25, 26, 27) - To assist the industry in combating fraud more effectively, consider: a) making claims fraud a punishable offence; b) requiring insurers to report fraud promptly; and c) promoting effective mechanisms for exchange of information between insurers with respect to fraud and those committing fraud (e.g. industry databases). - AML/CFT (ICP28) - Update the legislative framework for the AML/CFT regime in line with FATF standards and enhance clarity on the regulatory scope of the various regulatory agencies in AML/CFT supervision. ### Authorities’ responses (selected) - The authorities appreciate the IMF’s views and will take recommendations into account in developing the policy agenda for further insurance reforms. - Development and passage of legislation is subject to government priorities; timing cannot be guaranteed. - The Government considers the Treasurer’s power to issue directions to APRA on policies and priorities (but not particular cases) strikes an appropriate balance between accountability and transparency; to date the Treasurer has not given APRA any directions under this power. - The Treasurer agreed to move APRA’s financial framework to the Financial Management and Accountability Act (FMA Act) from the Commonwealth Authorities and Companies Act (CAC Act); the Government does not consider this will materially affect APRA’s operational independence or funding. - Processes are currently in place to amend the Financial Transaction Reports Act 1988 to allow AUSTRAC to share FTR information with APRA, including establishing a memorandum of understanding between the two authorities; under proposed AML/CTF legislation APRA will be included as a partner agency with which AUSTRAC can share FTR information. - Legislation to update the AML/CTF regime was expected to be introduced during 2006; the reforms when implemented will bring Australia into compliance with the FATF recommendations. *Source: IMF Financial Sector Assessment Program — Australia (excerpts from the assessment).* ### 40. In the last four years regulators and the financial services industry have been ### _cr06415 - 40. In the last four years regulators and the financial services industry have been ### B. Information and Methodology Used for Assessment - The assessor reviewed the legal framework for securities regulation, held extensive discussions with the staff of ASIC, APRA, the Treasury and participants in the banking and financial markets, and examined the current practice of ASIC’s supervision of financial services providers. - The assessor used a comprehensive self-assessment completed by the Australian authorities and received all required information. - Judgment was required to reach conclusions due to differing market structures and rapidly changing products, theories, policies, and best practices; a common, agreed methodology was adhered to for comparison with the IOSCO Principles. - Assessment approach to compliance with each Principle (qualitative): - Implemented: all assessment criteria generally met without any significant deficiencies. - Broadly implemented: inability to affirmatively answer applicable Key Questions limited to excepted questions under the broadly implemented benchmark and judged not to substantially affect overall adequacy. - Partly implemented: assessment criteria under the partly implemented benchmark generally met without any significant deficiencies. - Not implemented: major shortcomings found against the not implemented benchmark. - Not applicable: Principle does not apply given the market and structural, legal, institutional considerations. ### C. Capital Markets — Key Facts and Statistics - Global and market rankings: - Australia ranks globally as the seventh biggest foreign exchange market. - The $US/$AUS is the fourth most-traded currency pair. - The Australian dollar is the sixth most-trade currency. - The stock market is rated eighth largest in the world. - Australia has the tenth largest market for international debt securities. - Equities and turnover: - The Australian Stock Exchange Limited (ASX) accounts for over 99 percent of equities trading. - Average daily turnover was some $A 3.2 billion during 2004–05. - Of that turnover, some 78 percent came from institutional investors. - Between 1990 and 2005, total domestic capitalization of the 1,774 companies listed on the ASX increased by more than 500 percent to $A 975 billion at end-June 2005. - The ASX in 2004 was the fourth most active globally for capital raising—US$7.8 billion via 166 IPOs. - Forty-two percent of the market by value is owned by foreign institutions. - Derivatives and OTC: - ASX derivatives market traded some 22.6 million contracts during 2004–05. - Sydney Future Exchange (SFE) traded approximately 54.6 million contracts during 2004. - In 2004/5, total turnover for OTC transactions exceeded $A 58 trillion compared to total on-exchange turnover of $A 24 trillion. - Debt markets: - Australia’s share of global debt markets is around one percent. - As at end-March 2005, the total value of bonds on issue by domestic borrowers in Australia was approximately $A 260 billion. - The value of commonwealth government bonds on issue has been declining since 1997; the corporate sector is now the largest issuer of bonds in Australia. ### D. General Preconditions for Effective Securities Regulation - Macroeconomic and structural context: - Wide-ranging structural reforms over the past two decades strengthened monetary and fiscal frameworks. - Economic expansion that began in 1992 is now in its fourteenth year (at time of writing). - The unemployment rate has fallen by 6 percentage points since 1992. - Inflation has remained low and net public debt has been all but eliminated. - Financial system structure: - Financial system assets amount to over 300 percent of GDP. - Authorized deposit-taking institutions (ADIs: banks, credit unions, and building societies) account for about half of total financial system assets. - A further 23 percent of assets is held by life insurers and superannuation funds. - Stock market capitalization is over 100 percent of GDP. - Monetary policy framework: - Power to determine monetary policy conferred to the Board of the RBA by the Reserve Bank Act 1959. - Statement on the Conduct of Monetary Policy (1996; reaffirmed and updated in 2003) includes a commitment by the RBA to hold consumer price inflation to between 2 and 3 percent, on average, over the course of the cycle. - Monetary policy is conducted through the cash rate; open market operations keep the cash rate at or near an operating target set by the RBA Board. - Currency regime: - The Australian dollar was floated in 1983 and acts as an economic shock absorber by moving with external demand and commodity price fluctuations. - Shareholder rights: - Listed companies required to publish annual and half yearly audited accounts and hold annual general meetings subject to proper advice notice. - Continuous disclosure regime in place. - 5% of shareholders can call for an extraordinary general meeting. - Minority shareholder interests are protected; Takeovers Panel and ASIC provide oversight and intervention when necessary. - Legal system and rule of law: - Federal system with Commonwealth, six State Governments and two Territory Governments; Australian Constitution (1901) establishes separation of powers among Parliament, Executive, and Judiciary. - Parliament holds legislative power; Acts may confer powers on the Executive to make regulations, rules and by-laws. - Rule of law affirmed: authority constrained by law, equality before the law, predictable and fair laws, judicial independence, openness of courts. - Court system: Federal and State/Territory courts; judicial powers of the Commonwealth vested in the High Court of Australia. - Insolvency regime: - Corporations Act provisions focus on efficient winding up, orderly realization of assets, equitable distribution to creditors, employees and shareholders. - Three types of external administration: liquidation, receivership and voluntary administration. - Directors legally obliged to cause an insolvent company to cease trading or risk personal liability. - ASIC Act, Corporations Act and ASIC/APRA cooperative arrangements provide a sound basis for investigating and resolving problems. - Accounting and auditing: - From January 2005, Australia adopted International Financial Reporting Standards (IFRS) issued by the IASB; some Australian-specific standards retained. - Listed companies must lodge annual and half-yearly financial reports with ASIC prepared in accordance with IFRS; annual accounts audited; half-yearly reports subject to review or audit. - Large non-listed companies must lodge annual statements with ASIC; relief granted to “non-reporting companies”; exemptions for small non-listed companies. - Auditor registration required under the Corporations Act; ASIC must be satisfied that applicant meets qualifications and auditing competency standard. - There are currently 6110 registered auditors. - Auditing standards established by the Auditing and Assurance Standards Board (AUASB), based on International Standards on Auditing (ISAs); Financial Reporting Council oversees AUASB and AASB. ### E. Principle-by-Principle Assessment — High-Level Findings - Principles related to the regulator: - ASIC is operationally independent and appropriately funded, but several issues concerning its independence should be resolved. - Consultation on new regulatory issues is extensive; further public-private collaboration may improve effectiveness. - Principles related to compliance and enforcement: - Apart from weaknesses in the AML/CFT area (legislation lagging latest international developments and change imminent), ASIC’s legal powers are comprehensive and its use is effective and credible. - Principles related to information sharing and cooperation: - ASIC is a signatory to the IOSCO Multilateral MOU (MMOU) for exchange of information; commitment is undisputed. - Timeliness improvements have been identified as necessary and change is imminent; further improvements may be necessary pending review. - Principles related to issuers: - Corporate law and securities regulation mix appears to work well. - ASIC frequently facilitates takeover bids via exemptive relief and prevents misbehavior; it would be helpful if ASIC collated and published the advice it has given in recent years on prospectus disclosure. - Principles related to collective investment schemes: - Operators are subject to a comprehensive licensing system and risk-based supervision. - Greater specificity could be introduced into provisions governing conduct of fund managers when trading on behalf of clients. - Ongoing unit pricing errors should be closely monitored to determine if recent ASIC and APRA guidance has minimized the problem. - Principles related to market intermediaries: - Market intermediaries are subject to a comprehensive licensing system and risk-based supervision. - Detailed regulations govern firm/client relationships. - ASIC’s risk-based capital requirements do not fully match international best practice. - Principles related to secondary markets: - The Minister licenses exchanges and clearing and settlement facilities (CSFs); rule changes must be submitted to the Minister and are subject to disapproval. - Day-to-day supervision is carried out by ASIC, which conducts annual compliance reviews. - It may be appropriate to review the case for the Minister retaining licensing and disapproval powers. - ASIC’s risk-based capital requirements for large exposures are not sophisticated enough for an OTC market of growing size and complexity. ### Principle 1 — The responsibilities of the regulator should be clear and objectively stated - Description and legal basis: - The Australian Securities and Investments Commission (ASIC) regulates the provision of financial services. - The ASIC Act 2001 sets out functions and powers conferred upon ASIC by other legislation including: - Corporations Act 2001 - Insurance Contracts Act 1984 - Superannuation (Resolution of Complaints) Act 1993 - Life Insurance Act 1995 - Retirement Savings Accounts Act 1997 - Superannuation Industry (Supervision) Act 1993 - The Corporations Act (CA) is the most important Act for regulation of financial intermediaries. - The Financial Services Reform Act 2001 (FSRA), effective in 2002, introduced numerous fundamental changes to the CA, including a new licensing system; further changes or refinements to FSRA were, at the time of writing, in process and expected to impose transitional costs and pressures on intermediaries. - ASIC and APRA responsibilities and prudential overlap: - The responsibilities of ASIC are clearly defined and transparently set out. - The Australian Prudential Regulation Authority (APRA) is the prudential regulator of banks, building societies, credit unions, insurance companies, and friendly societies. - Financial services providers not falling within APRA’s categories (e.g., financial advisers, and non-bank securities and derivatives brokers and dealers) are subject to capital requirements and other prudential-type regulation by ASIC. - These requirements are targeted to ensure a financial services provider: - has sufficient financial resources to conduct its affairs in accordance with its statutory obligations - has a financial buffer sufficient to limit the risk of a disorderly or non-compliant wind-up if the business fails - is structured so as to incentivise its owners to comply through fear of financial loss *Source: _cr06415 - 40. In the last four years regulators and the financial services industry have been* ### Section 1(2) of the Act requires ASIC to ‘strive to maintain, facilitate and improve the ### _cr06415 - Section 1(2) of the Act requires ASIC to ‘strive to maintain, facilitate and improve the ### ASIC mandate and statutory role - Section 1(2) of the Act requires ASIC to “strive to maintain, facilitate and improve the performance of the financial system and entities within that system ....reducing business costs...” and to “promote the confident and informed participation of investors.” - Section 12a(2) describes one of ASIC’s functions as “... monitoring and promoting market integrity and consumer protection in relation to the Australian financial system.” - ASIC does not have the power to issue legally enforceable rules or regulations on financial services providers or corporations; the Minister issues regulations (which may be disallowed by Parliament). ### Rulemaking, guidance and exemptive relief - ASIC implements regulations and accompanying legislation and issues Policy Statements to guide interpretation of regulations and legislation. - ASIC has statutory power to grant exemptive relief from some parts of the CA: - ASIC can exempt a person or a class of person from certain provisions of the CA. - It can declare that a chapter of the CA applies as if a specified provision were omitted, modified or varied. - Class order relief, with a Regulatory Impact Statement where required, must be tabled in each House of Parliament and can be disallowed by negative resolution. - ASIC publishes all policy statements, practice notes, individual relief instruments and class orders in the ASIC Gazette and posts them on the ASIC web site. - Assessment: Implemented. - Comment: ASIC’s power to grant exemptive relief is an important tool to address unintended consequences; it is widely used in practice (for example, almost all corporate takeovers require ASIC to use the power to facilitate the transaction). ### Cooperation and information exchange with APRA - An MOU between ASIC and APRA (signed June 2004) provides a framework for cooperation and the exchange of confidential information, with obligations expressed as positive obligations of “will notify”, sometimes modified by “best endeavors”. - The MOU seeks to preserve confidentiality, though it does not prevent lawfully permitted disclosure by the receiving agency. - Since the MOU, the number of occasions when information has been exchanged has increased significantly. - Assessment: Implemented. ### Operational independence and accountability (Principle 2) - Description: - ASIC is part of the executive branch and responsible to the Treasurer (‘the Minister’); the level of operational independence “appears high.” - Ministerial powers that affect operational independence: - s12(1) ASIC Act: Minister may give ASIC a written direction about policies or priorities. Such a direction must be public. The Minister has used this power only once, in 1992. ASIC must comply. - s14 ASIC Act: Minister may direct ASIC to carry out an investigation if he believes it is in the public interest; ASIC must comply and prepare a report for the Minister who may publish it whole or in part. The matters on which a direction to investigate can be made are wide ranging. - Funding: ASIC is funded out of the Government’s budget as approved by Parliament within an ‘outcomes and outputs’ framework intended to provide sufficient funds to obtain “a fair and efficient market characterized by integrity and transparency and supporting confident and informed participation of investors and consumers.” - Revenues from corporations fees and charges exceed the funding provided to ASIC because revenues are intended to cover other costs including compensation payments to the States and notional allocations to other bodies. - The scheme ran at a cumulative loss for many years; that trend is “now beginning to reverse.” - The cost recovery regime is scheduled for review in 2007/8 as part of a broader program of reviewing cost recovery by the Government. - Recent increases in ASIC’s funding have been related to expansions of ASIC’s regulatory role and funding for high-cost enforcement actions (for example the HIH investigation). - Appointment and protections: - Commission members appointed for terms of up to 5 years; reappointment possible; Minister obliged to appoint persons with relevant knowledge or experience. - s246 ASIC Act: ASIC, the Commissioners and its staff are protected from legal liability in relation to an act done or omitted in good faith in performance of their functions and exercise of powers under the law. - Accountability mechanisms: - Comprehensive annual report (including audited accounts) tabled in Parliament. - Oversight: Joint Parliamentary Committee on Corporations and Financial Services; Senate Estimates Committee; ad hoc Parliamentary committees. - Class order reliefs tabled in each House of Parliament and can be disallowed by negative resolution. - Freedom of Information Act rights subject to exceptions. - Procedural fairness: persons subject to a decision by ASIC are entitled to a hearing before that decision is made and reasons must be provided in writing. - All ASIC decisions are subject to judicial review; Administrative Appeals Tribunal (AAT) may review on the merits. - Public consultation by the Minister and ASIC on new regulations and policy initiatives, generally accompanied by a Regulation Impact Statement. - Assessment: Broadly implemented. - Comments and risks: - Ministerial direction and investigation powers are viewed officially as a fallback; direction power used only once (1992) and investigation power never used. - Funding method raises two issues: - Reliance on the government for entire income creates vulnerability to budget cuts (example: 1995–1997 when ASIC made more than 300 staff redundant and closed a major program). - Growing proportion of funding tied to specific purposes and limited duration may limit ASIC’s operational independence over time. - The Government’s decision to implement the Uhrig Review recommendation that ministers issue Statements of Expectation to statutory authorities (including ASIC) “will also need careful nuancing” to avoid impression of fettering ASIC’s powers. ### Powers, resources and capacity (Principle 3) - Description: - ASIC has a broad range of powers reflecting civil and criminal jurisdiction and diverse responsibilities as regulator of the corporate sector, markets regulator and regulator of financial services providers. - For financial services providers ASIC has comprehensive powers of licensing (including conditions), supervision, inspection, investigation and enforcement. - Funding is currently adequate and ASIC can allocate funds as it thinks appropriate except for special purpose funds. - Staffing: - ASIC attracts high quality graduates but retention beyond three years has been difficult; turnover has reduced from over 20 percent to around 12 percent. - Additional costs related to recent salary increases have been funded out of the existing budget allocation. - ASIC provides extensive funded opportunities for professional training and uses secondees from industry (currently primarily from insolvency practitioners). - Assessment: Implemented. - Comment: See Principles 8 and 9 for detailed discussions on powers. ### Clear and consistent regulatory processes (Principle 4) - Description: - ASIC has developed policy statements and practice notes to ensure consistent administration of the CA and the ASIC Act; these are publicly available on the ASIC website. - Neither the Minister nor ASIC has a legal obligation to consult affected parties, but there is a strong tradition and public presumption of consultation in practice. - Consultation practices: - ASIC consults extensively; consultation period is normally three months and usually accompanied by a Regulation Impact Statement (RIS). - The Minister has adopted the same policy with regulations for which he has sole responsibility. - Freedom of Information Act and procedural fairness apply as described under Principle 2. - ASIC promotes investor education (examples: FIDO consumer protection website; ‘Your Money’ publication). Treasury established and funded the Financial Literacy Foundation in June 2005 for financial literacy initiatives. - Assessment: Implemented. - Comments: - Room for improvement in consultation process; suggestions include earlier and less formal consultation and greater involvement of front line operational, compliance and IT staff from the private sector. ### Staff standards and confidentiality (Principle 5) - Description: - All staff required to adhere to Australian Public Service Values and the Australian Public Service Code of Conduct. - ASIC operates on basis of full disclosure for staff holding and trading financial instruments rather than restrictions. - ASIC and its staff subject to the Privacy Act. - Public Service Act provides sanctions for breaches of requirements. - Assessment: Implemented. - Comments: Only one instance of staff abusing position of trust for personal gain occurred about fifteen years ago; complaints from persons under investigation are examined internally and none have been assessed as well founded. ### Use of Self-Regulatory Organizations (Principles 6 and 7) - Description: - ASIC considers there are no SROs in Australia since ASIC is the sole licensing authority for financial services providers. - Entities licensed as markets (AMLs) and clearing and settlement facilities (CSFLs) perform certain self-regulatory functions (eligibility rules, trading rules, disciplinary rules and sanctions). - Assessment: Implemented. - Comment: IOSCO has indicated there are no criteria for Principle 6. Regulatory functions of exchanges and their regulation by ASIC are described in Principles 25 and 26. ### Inspection, investigation and surveillance powers (Principle 8) - Description: - Criminal offence to carry on a business of providing financial services without an Australian Financial Services License (AFSL) except as a representative (s911A CA). Sanctions: a fine of A$ 22,000 or 2 years in prison or both. - s29 ASIC Act: power to inspect books required to be kept under the corporations legislation without prior notice; failure to provide access is a strict liability offence. - ASIC may, without prior warning, serve notices requiring production of books on all corporations including exchanges and clearing houses (Sections 31,32A, 33 ASIC Act). 11,000 notices were issued in 2004. - Failure to comply may lead to court referral, orders to comply, contempt of court penalties (fine or imprisonment). - ASIC may apply for and execute a search warrant (s35,36 ASIC Act) and under the Crimes Act (executed with police attendance) to facilitate seizure of at-risk articles. - CA gives ASIC powers to require information concerning acquisition or disposal of financial products and impose assistance obligations on financial services license holders and operators of exchanges and clearing houses. - Record keeping: records must be retained for seven years. - AML/CFT gap: - Australia enforced anti-money laundering legislation since 1988 (Financial Transaction Reports Act 1988 (FTR)) but requirements are limited and applied only to ‘cash dealers’. - The October 2005 FATF Mutual Evaluation Report highlighted significant limitations. - ASIC has no power to impose comprehensive customer due diligence requirements on AFSL holders as required by the FATF 40+9 Recommendations. - Neither ASIC nor AUSTRAC has an explicit power to revoke an AFSL or remove an individual from the management of a license holder for breach of the FTR; indirect action based on breaches of financial services laws is possible but untested. - ASIC has not imposed any sanctions for AML/CFT failings. - Assessment: Not implemented. - Comment: The Australian Government is reviewing its anti-money laundering regime; a draft bill for public consultation was released on 16 December 2005. Restrictions exist on uses of material obtained under search warrants executed under the Crimes Act; ASIC is seeking an amendment to the law. ### Comprehensive enforcement powers (Principle 9) - Description: - ASIC may commence investigations where there is suspicion of contravention of the CA or other laws concerning management or affairs of a corporation, collective investment scheme, or involving fraud/dishonesty. - ASIC can commence civil proceedings seeking civil penalty orders, disqualification or compensation; can apply for restraining or directing orders; can seek fines up to A$ 200,000 for an individual and up to A$ 1 million for a corporation. - ASIC may bring criminal proceedings (minor summary prosecutions undertaken by ASIC; other cases referred to the Commonwealth Director of Public Prosecutions (CDPP)). - Administrative powers include banning a person from providing financial services, issuing infringement notices for continuous disclosure breaches, and stop orders on defective disclosure to retail investors. - ASIC can order suspension of trading on an exchange of a security or derivative. - ASIC can negotiate and accept “enforceable undertakings”; breaches permit ASIC to obtain a court order to compel ongoing compliance without proving the original contravention. - Assessment: Implemented. - Comments: - ASIC lacks a more extensive administrative fining power beyond recently introduced infringement notices for continuous disclosure breaches; payment of such notices is not mandatory but failure to pay may trigger civil penalty action. - Preparation of briefs by ASIC usually includes discussion with CDPP, limiting the risk of the CDPP declining to act. - Civil proceedings seeking management banning orders impose rigorous procedural burdens on ASIC; courts treat banning as a penalty and require a standard of proof slightly higher than balance of probabilities. - Enforceable undertakings have demonstrated effectiveness in high profile cases. ### Inspection, surveillance, enforcement outcomes and compliance programs (Principle 10) - Description and outcomes: - 2004/5 annual report highlights: - 27 criminals jailed for a total of 96 years and 23 others convicted. - Obtained A$ 119 million in recoveries, costs, compensation and fines with more than A$ 5 million frozen. - Banned 58 people from managing corporations or offering financial services. - Disciplined 12 company auditors and liquidators for misconduct and wound up 60 companies. - Jailed two superannuation scheme promoters; halted 5 suspect schemes involving at least A$ 14 million; closed down 76 other illegal schemes involving 2150 investors and A$220 million. - Secured five criminal convictions and 2 civil penalty orders for insider trading and market manipulation. - As of April 2005: - 4091 AFSL license holders. - Over 45,000 ASIC registered authorized representatives. - Inspection strategy: - ASIC favors risk-based inspection programs over periodic inspections and has developed STIRS (entity-based risk scoring system) for licensing and a surveillance risk-based process; consideration being given to combining systems. - Targeting factors include frequency of complaints, notification by licensee of significant breaches, and ASIC campaign-based analysis of emerging risks. - Activity levels (2004/5): - 938 compliance or compliance related visits. - 865 campaign-based visits. - These visits amount to more than 40 percent of licensees (allowing for some repeat visits). - Market surveillance: - Primary responsibility for day-to-day market monitoring lies with market operators (ASX and SFE) using automated techniques; unusual transactions referred to ASIC. - ASIC monitors the equity market using electronic systems with different parameters to ASX. - Complaints and dispute resolution: - Almost 10,000 investor complaints received in 2004/5, an increase of 7 percent over the previous year. - A dedicated team of 100 handles complaints. - Licensees providing financial services to retail clients must have internal dispute resolution mechanisms and be members of an ASIC approved external dispute mechanism. - Assessment: Implemented. - Comment: ASIC’s status among the general public appears to be growing as reflected in media coverage. _*Source: _cr06415 - Section 1(2) of the Act requires ASIC to ‘strive to maintain, facilitate and improve the_ (PDF chapter/section)* ### references in the specialized and even popular mass-audience TV programs, which may account ### _cr06415 - references in the specialized and even popular mass-audience TV programs, which may account ### ASIC institutional standing and enforcement practice - ASIC staff "well regarded in the industry" and "no negative comments were received during the assessment." - Some criticisms exist of ASIC methodologies such as "shadow shopping" and that ASIC "places too much emphasis on procedural matters under the law"; these criticisms "are not fundamental." - Most ASIC powers in this area "have been in force since 1990 and are well tested." - "Notices requiring the production of books and records are rarely if ever challenged." ### Risk-based surveillance - Risk based approach is intended "to be the primary mechanism by which the activities of licensees are monitored." - Recommendation: "a clearer articulation of objectives and the identification and adoption of a comprehensive suite of tools for identifying and prioritizing risk would be helpful in maximizing its implementation." ### Principle 11 — Authority to share public and non-public information - Australia is signatory of the IOSCO Multi-lateral Memorandum of Understanding (MMOU). - Section 127 ASIC Act authorizes ASIC to share public and non-public information with domestic authorities for "investigation and enforcement, licensing, approvals and surveillance activity." - ASIC may provide information to foreign regulatory authorities under s127(4)(c) "if the Chairman is satisfied that it will assist the foreign authority to perform its powers or functions conferred by a law in that country." - The Chairman "may, and as a matter of practice does, impose conditions" on disclosure to foreign regulators. - If compulsory powers are required to obtain information for transmission to a foreign regulator: - The foreign regulator must request under the Mutual Assistance in Business Regulation Act 1992 (MABRA) and ASIC must obtain the consent of the Attorney General. - If the request concerns criminal matters the foreign regulator must apply under the Mutual Assistance in Criminal Matters Act 1987 (MACMA). - For MABRA requests it is "normally necessary for foreign regulator to be required to state that the information is not sought for the purpose of a criminal investigation." - If later the requesting authority needs to pass information on to a criminal authority, it may notify ASIC and request ASIC to confirm Attorney-General consent to on-release. - Standard conditions ASIC imposes on confidential information released under section 127: - A requirement that the foreign regulator takes reasonable steps to maintain the confidentiality of the information released; - If the foreign regulator propose to release it to any other parties, such as another regulator or law enforcement agency, that ASIC's consent be sought prior to doing so; - The information may only be used or further disclosed by the foreign regulator for the purpose of enabling or assisting it to perform or exercise one or more of its functions or powers and for no other purpose. - Where information is released pursuant to the IOSCO MMOU, the first two conditions are not imposed; ASIC refers to specific MMOU requirements instead. - Rationale for confidentiality conditions: ASIC "is under an obligation to take reasonable measures to protect" the information (section 127(1) ASIC Act) and release may prejudice concurrent ASIC investigations. - ASIC has not recently refused consent to provision of confidential information to another foreign regulator where consent has been sought. - Assessment: Implemented. - Comments: "For commentary on an outstanding issue concerning responding to requests for overseas regulators see Principle 13." ### Principle 12 — Information sharing mechanisms and MOUs - ASIC has power to enter into information sharing agreements with domestic or foreign securities regulators. - Existing domestic MOUs include APRA, RBA, ACCC, the taxation office, stock and derivatives exchanges (ASX and SFE). - ASIC has entered into "about 35 bilateral MOUs with foreign regulatory authorities." - ASIC is a signatory of the IOSCO Multilateral MOU. - ASIC can assist domestic or foreign regulators under the ASIC Act "even if there is no formal MOU in place." - Assessment: Implemented. ### Principle 13 — Assistance to foreign regulators (timeliness and mechanisms) - ASIC can provide publicly available information to foreign regulators "as a matter of course." - ASIC can share confidential information under s127(4)(c) ASIC Act. - Subject to Attorney General approval, ASIC can compel production under MABRA; for foreign serious offences can use MACMA powers (seize, forfeit, recover pecuniary penalties, restrain dealings). - Timeliness: - Delays of "up to 12 months have been known in the past although the current average is 2-3 months." - A request for assistance under MABRA must follow a detailed legislative checklist. - Resource constraints in the Attorney General's department contribute to delays. - Planned operational change: responsibility for operating MABRA will shortly transfer from the Attorney General’s department to the Treasury with the expectation that "the assignment of dedicated staff will reduce the response time to about two weeks." - Caveat: In certain circumstances, e.g., freezing a bank account as part of a civil enforcement action, "two weeks may still be too slow." - Suggested further consideration: "whether to take the further step of adopting international best practice and giving ASIC the authority to acquire the information and transmit it directly to its counterparts overseas without first having to seek the Minister’s permission." - MABRA typical conditions (section 7(2) guidance) may address: - Confidentiality of the information provided; - The storage of, use of, or access to, the information provided; - Copying, returning or disposing of copies of documents provided in compliance with the request. - Review of recent MABRA conditions shows they tend to require that: - Foreign regulator not pass the information to a criminal authority without notifying the Attorney General or his delegate; or - The information provided is not to be used as evidence in criminal proceedings without the prior consent of the Attorney General or his delegate. - MACMA typical conditions: - Information, documents or evidence provided to the foreign criminal authority will only be used for the purpose for which it was provided; - The information, documents or evidence provided will not be released to another authority without the consent of the Attorney General. - Assessment: Implemented. - Comments: "The problem of timeliness can limit the effectiveness of the assistance given." ### Principle 14 — Disclosure by issuers (offers, periodic reporting, listed securities, derivatives) - Offers of securities: - General provision in the CA: "an offer of securities requires disclosure to investors (s706)." - Required disclosure may take the form of "a prospectus, short form prospectus, profile statement or offer information statement." - Derivatives: separate disclosure regime; issue of derivatives accompanied by a "product disclosure statement (PDS)." - A short form prospectus may refer to material lodged with ASIC and inform readers of the right to obtain a copy free of charge. - With ASIC approval a profile statement may be sent without a prospectus; a prospectus must still be lodged and provided on request free of charge. - An offer information statement may be used instead of a prospectus if the amount to be raised plus amounts previously raised under an information statement is "A$5 million or less." - Exempt offerings: offers to less than 20 investors or for less than "A$2 million in a 12 month period" and offers to sophisticated investors (defined as minimum amount payable by an investor is "A$500,000"). - Prospectus content: - Section 710 CA: prospectus must contain "all information that investors and their advisers would reasonably require" to make an informed assessment, including rights and liabilities attaching to securities, assets, liabilities, financial position and performance, profits, losses and prospects. - Specific disclosure requirements include fees and benefits to directors. - Disclosure documents must be "worded and presented in a clear concise and effective manner." - Offences and liability: - It is an offence to continue an offer after becoming aware of a misleading or deceptive statement, omission or new circumstance unless corrected by lodging a supplementary document with ASIC. - The offer can supply a supplementary document and give investors "one month to withdraw the application and be refunded (s724(2) CA)." - Civil liability exposure exists for misleading or deceptive statements or omissions on directors, underwriters and named professional advisers. - Advertising a public offer outside of a prospectus is an offence apart from narrowly defined exceptions. - Periodic reporting: - Disclosing entities (public companies, large proprietary companies and all collective investment schemes) must prepare a financial report and directors report for each financial year. - Annual financial reports must comply with accounting standards. "(At the beginning of January 2005 Australia moved to a modified version of International Financial Reporting Standards (IFRS))." - Disclosing entities must prepare half-year financial and directors reports; contents are specified in the CA and "must comply with accounting standards and present a true and fair view." - Disclosing entities must send copies of annual financial report, directors’ report and auditors report to members or a concise report with an offer to provide full reports free of charge on request. - Reporting deadlines: - Disclosing entities (except collective investment schemes) must report to members by the earlier of "21 days before the next AGM or 4 months after the end of the financial year." - Deadline for most collective investment schemes is "3 months after the end of the financial year." - All public companies must file annual and half yearly reports with ASIC; collective investment scheme reports must be filed "three months after the end of the financial year." - Exchange-listed entities and some unlisted entities have continuous immediate disclosure obligations for events material to securities prices; exemptions exist for certain categories (e.g., significant but partly completed transactions). - Listed securities and exchanges: - Regulations under the CA require licensed market operating rules to cover admission to official list, conduct of listed entities, and disciplinary action. - Exchange rules include grounds to suspend trading and "a requirement to produce information to correct or prevent a false market even if that information had not been disclosed because of an exception relating to confidential information." - Listed entities may request a trading halt for up to "two days." - Derivatives: - Dominant derivatives markets: "the SFE and ASX." - Regulations set out disclosure requirements for derivatives contracts traded on an exchange; market rules address contract terms, trading mechanics and risks related to gearing and leverage. - Assessment: Broadly implemented. - Comments: - Prospectus legislation is "unusual compared to international norms" because it does not list detailed mandatory items beyond general obligations. - Approach is principle-based; disclosure obligations interpreted in light of general obligations and ASIC judgment. - ASIC reviews prospectuses and "frequently does, issues ‘stop orders’" where disclosure is inadequate; stop orders are public. - Lack of consolidated Policy Statement: "there has been no Policy Statement for several years that brings together in one or more documents, the many expressions of view that ASIC staff have made." - ASIC intends "to issue, for consultation, a policy statement to achieve this and other goals very early in 2006." ### Principle 15 — Fair and equitable treatment of security holders - Director appointments: - A company may appoint a new director by resolution in a general meeting (s201G) or by other direction (s201H). - If directors appoint a director to a public company the appointment "is to be confirmed at the next AGM." - These requirements are in replaceable rules and may be modified by the company’s constitution (s135). - Member remedies: - Members (and others) may apply to court if company conduct is "contrary to the interests of the members as a whole or oppressive, unfairly prejudicial or unfairly discriminatory against members." - Remedies and rights in bankruptcy/insolvency include: - the right to apply to the court for a review of a liquidator's remuneration; - the right to apply to the court to stay the court winding up; - the right to apply to the court to have questions determined in a creditors voluntary winding up; - the right to require the liquidator to convene a meeting in certain circumstances. - Exchange listing rule example: ASX requires shareholder vote for acquisition or disposal of an asset "worth more than 20 percent of the business." - Disclosure obligations reinforcing fairness: - Changes in directors holdings must be disclosed "within two days." - Persons with a significant holding must make their first public declaration at "five percent" and subsequently for every "one percent" move up or down. - "Twenty percent is the takeovers threshold." *Source: _cr06415 - references in the specialized and even popular mass-audience TV programs, which may account* ### Section 671B(6) of the Corporations Act provides the deadline for disclosure of a substantial ### _cr06415 - Section 671B(6) of the Corporations Act provides the deadline for disclosure of a substantial ### Deadline for disclosure of a substantial shareholding - Section 671B(6) of the Corporations Act provides the deadline for disclosure of a substantial shareholding (or change in that substantial shareholding) in a listed company or listed managed investment scheme (i.e.: a collective investment scheme). - The information is to be disclosed: - Within two business days after the person becomes aware of the substantial shareholding or change in their holding; - By 9:30 am on the next trading day of the relevant market, once the person becomes aware of the substantial shareholding or change in their holding, and this occurs during a takeover bid for the voting shares of the company or managed investment scheme. ### Takeovers and other changes of control transaction - 110 - Chapter 6 of the CA relates to takeovers and is underpinned by four principles, known as the Eggleston Principles, which seek to ensure that: - the acquisition of control takes place in an efficient, competitive and informed market - shareholders and directors know the identify of any person who proposes to acquire a substantial interest in the company and are given enough time and sufficient information to enable them to assess the merits of the proposal - as far as practicable the holders of the relevant class of voting shares or interest all have a reasonable and equal opportunity to participate in any benefits accruing to the holders through any proposal under which a person would acquire a substantial interest in the company - an appropriate procedure is followed as a preliminary to compulsory acquisition of voting shares or interest in any other kind of securities *Source: _cr06415 - Section 671B(6) of the Corporations Act provides the deadline for disclosure of a substantial* ### Chapter 6 of the CA contains detailed provisions that implement the Principles. Contravention ### _cr06415 - Chapter 6 of the CA contains detailed provisions that implement the Principles. Contravention ### Takeovers framework and enforcement - Chapter 6 of the CA contains detailed provisions that implement the Principles; contravention carries a range of sanctions. - Takeovers Panel: - Will consider the Eggleston Principles when determining whether to make a declaration of ‘unacceptable circumstance’. - Does not need a finding of an actual contravention of the CA to declare unacceptable circumstances. - Frustrating actions by directors will generally be found to have created unacceptable circumstances and will be overturned by the Panel. - Funded by the Treasury; its orders are enforceable in the courts. - Main forum for resolving disputes about a takeover bid during the bid period. - Common problem: identifying concert parties where two or more persons have secretly agreed to secure control; practitioner experience of part-time members is invaluable. - Panels: Three of the Panel’s 47 members are appointed to make a decision on a particular case; in the case of an initial review a second group of three will review the case on its merits. - Bid timing and procedural rules: - A takeover offer must last for at least one month. - Offer duration extended by 14 days if within the last 7 days the terms of an off-market offer are varied or the bidder’s voting power in the target increases to more than 50 percent. - Bidder’s statement requirements: - Must be prepared and sent to ASIC, the target, its shareholders and the market (if applicable). - If the bidder is a director or holds 30 percent voting power in the target, the statement must be accompanied by an independent expert’s report on whether the offer is fair and reasonable. - Required content includes identity of the bidder, intentions regarding the business of the target, details of cash or securities offered, details of any benefits offered during the four months prior to the bid likely to induce acceptance, and any other information material to holders of bid class securities. - Sanctions exist for bidder or target failing to correct statements they know to be misleading or deceptive. - Equality and special rules in off-market and on-market bids: - Conventional takeover bid must be for all securities in the bid class. - Off-market bid must be for all securities in the bid class or a specified proportion the same for all holders. - Prohibitions on selective benefits, conditions allowing acquisition from some but not all acceptors, and constrained pricing rules. - Off-market cash-only bid rule: if bidder purchases securities in the bid class outside the bid and during the bid for a price higher than the bid price, the consideration payable under the bid price increases to that higher amount. - If bid includes non-cash components, a holder is entitled to accept on a cash-only basis for an amount equivalent to the highest paid outside the bid during the bid period. - If a proportionate off-market bid leaves a holder with an unmarketable parcel, the bid extends to those shares on the same terms. - If the bidder purchased securities in the bid class in the four months prior to the bid, the consideration under the bid must be equal to or exceed the maximum price paid in those four months. - All telephone calls between bidder/target and holders to discuss the bid must be recorded, indexed and stored; ASIC can listen to recordings in certain circumstances. - Foreign holders and compulsory acquisition: - Offers to foreign holders need not be in securities in certain circumstances (e.g., local registration requirements). - If bidder and associates have interests in 90 percent and have acquired at least 75 percent of the bid class securities, the bidder can buy the balance compulsorily on the same terms; conversely a minority shareholder can require the bidder to buy out his holding. - Schemes of arrangement: - CA contains safeguards for shareholders when a company enters a scheme of arrangement; schemes are overseen by the courts and ASIC is given time to examine proposals and make submissions to the court. *Assessment: Implemented* --- ### Principle 16 — Accounting and auditing standards - Accounting standards: - Two responsible bodies: Australian Accounting Standards Board (AASB) and Financial Reporting Council (FRC), both established under the ASIC Act. - From January 1, 2005 Australian accounting standards have used a modified version of International Financial Reporting Standards (IFRS). - AASB 101 requires financial reports to be relevant, reliable, comparable and understandable; information presented consistently for comparability across periods and entities. - Australia’s accounting profession widely recognized as meeting a high international standard. - Auditing standards and oversight: - Two responsible bodies: FRC and Australian Auditing Standards Board (AUASB); AUASB established under the ASIC Act and sets standards; FRC has oversight. - Australian auditing standards based on International Standards on Auditing. - Auditors must register with ASIC; ASIC must form an opinion that applicant has necessary qualifications, satisfies auditing competency standard and is capable of performing duties of an auditor. - Oversight provided by ASIC and professional accounting bodies; disputes decided by the Companies Auditors and Liquidators Disciplinary Board. - CA contains extensive provisions on auditor independence and numerous offences for breaches by auditors, audit firms, members and directors. - Reforms and surveillance: - Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act amendments to the Corporations Act came into force on 1 July 2004. - ASIC introduced ongoing surveillance for auditors including on-site visits with initial focus on the ‘Big 4’; second tier audit firms are current focus. - Initial ASIC auditor inspection program (to 1 November 2005) focused on auditor independence; program expanded to include audit methodology and application of Australian Audit Standards. *Assessment: Implemented* - Comments: - Early indications of move to IFRS focus on earnings volatility, valuations and systems. - Increased compliance costs for valuation of defined benefit pension plans, financial instruments, etc., due to lack of internal expertise. - Earnings volatility likely to rise from external factors (investment properties and financial instruments). - Need for upgrades to internal accounting systems. --- ### Principles for Collective Investment Schemes (Principles 17–20) Principle 17 — Eligibility and regulation of operators/marketers - Structure and responsible entity: - In 1998 Australia replaced dual manager/trustee structure with a single responsible entity legally responsible and accountable for the entire operation of the managed investment scheme (cis). - About 600 responsible entities licensed to operate 4500 schemes. - Superannuation differs (prudentially regulated by APRA); A$60 million in financial assistance grants to date for fraud in superannuation funds. - Licensing and AFSL obligations: - Operators and marketers of managed investment schemes must hold an Australian Financial Services License (AFSL). - Licensees must: - Do all things necessary to ensure financial services are provided efficiently, honestly and fairly. - Have available adequate human, financial and technological resources. - Maintain competence to provide those financial services. - Ensure representatives are adequately trained and competent. - ASIC publishes Policy Statements detailing assessment of requirements and has a range of sanctions for breaches. - Penalties for unlicensed schemes: - Natural persons: fine up to $A 22,000 or imprisoned for 5 years. - Corporations: fined up to A$ 110,000. - CA enables ASIC or others to apply to the court for winding up; in 2003/4 ASIC took action against 60 illegal schemes involving around 5000 investors and $A 110 million. - Cross-jurisdictional arrangements: - ASIC relies on cooperative arrangements with overseas regulators and legal position that outsourcers remain accountable for agents’ actions. *Assessment: Broadly implemented* Principle 18 — Legal form, segregation and protection of client assets - Governance and constitution: - A managed investment scheme must have a governing document (constitution) addressing acquisition consideration, powers, borrowings, complaints, fees, indemnities, withdrawal rights and winding up. - Responsible entity duties include holding and use of scheme assets and acting in members’ best interests. - Disclosure to retail clients: - Product Disclosure Statement (PDS) required for retail offers; ASIC guidance on form and content. - Safeguards and oversight: - Responsible entity must have majority external directors or a compliance committee with a majority of external members. - Independent auditor must audit the compliance plan each year and notify ASIC of serious contraventions. - Scheme property and custodianship: - Scheme property must be clearly identified and held separately; held on trust for scheme members. - Responsible entity acting as its own custodian must have at least $A 5 million in net tangible assets; otherwise a custodian must be appointed. - ASIC issued PS 133 (custodian standards) and PS 181 (conflict management when using related entity as custodian). - Winding up: - Various winding-up mechanisms including court orders; responsible entity must ensure winding up per constitution and court orders. *Assessment: Implemented* Principle 19 — Disclosure to evaluate suitability and value - PDS requirements: - PDS must be dated, current, clear, concise and effective, and contain material information reasonably expected to influence a reasonable retail client. - Required PDS content includes: - Name and contact details of the issuer - Information about significant benefits and timing - Information about significant risks - Information about costs and any other amounts payable - Information about any commissions or other payments that may impact on returns - Information about any other significant characteristics or features - Information about the rights, terms, conditions and obligations attaching to the product - Information about the disputes resolution system - General information about any significant tax implications - Information about any cooling off period - ASIC issued PS 168 with detailed guidance on PDS disclosure issues. - Short-Form PDS: - From 15 December 2005 a responsible entity can provide a Short-Form PDS to retail clients instead of the PDS; retail client must be informed a PDS is available and how to access it. - ASIC intervention powers: - ASIC can issue stop orders where the PDS or related advertisement is defective or where dispute resolution is inadequate. *Assessment: Implemented* - Comments: - Statutory requirement that a PDS be ‘clear, concise and effective’ has not been achieved in practice; reforms may reduce PDS length and improve clarity. Principle 20 — Asset valuation, pricing and redemption - Valuation and compliance: - Assets must be valued at regular intervals appropriate to the nature of scheme property. - Compliance plan must be lodged with ASIC; ASIC issued PS 132 addressing valuation issues. - Applicable accounting standards provide guidance for difficult assets such as property. - Constitution must set fair procedures for withdrawals; ASIC expects withdrawal and acquisition prices to be ‘independently verifiable’. - Responsible entity liable if a valuer it engages fails to meet standards. - Constitution must make adequate provision for independently verifiable pricing and redemption of units. *Assessment: Broadly implemented* - Comments: - Series of unit pricing errors totaling over $A 240 million involving large managers and tens of thousands of investors. - Operators generally compensate investors when errors discovered; doubts remain whether all errors have been discovered. - ASIC actions: enforceable undertakings, guide to good practice in unit trust pricing (in consultation with APRA), and monitoring performance against recommendations. - Some in APRA believe the problem may never be fully solved. --- ### Principles for Market Intermediaries (Principles 21–24) Principle 21 — Minimum entry standards (AFSL) - AFSL regime: - All persons carrying on a financial services business in Australia must hold an AFSL. - Offence for carrying on financial services without a license: fine up to $A 220,000 or 2 years jail or both. - A person is providing a financial service if they: - provide advice on financial products - deal in a financial product - make a market in a financial product - operate a registered managed investment scheme - provide a custodial or depository service - CA (s912A) sets high-level but comprehensive requirements for applicants, including honest, efficient and fair provision of services; conflict management; compliance; adequate resources; competence; risk management; dispute resolution for retail clients. - ASIC provides Policy Statements and an internal licensing guide (LARA) to ensure consistent processing. - ASIC must grant a license if application correct, no reason to believe applicant will not comply with statutory requirements, and no reason to believe applicant or responsible officers are not of good fame or character. - License scope restricts activities to those applied for and considered competent. - Enforcement mechanisms: - CA (s912D) requires licensees to notify ASIC of significant breaches or likely breaches. - ASIC’s policy: more rigorous enforcement if ASIC uncovers breach rather than licensee self-reporting. - ASIC can impose or vary license conditions, suspend or cancel a license, and issue banning orders. - Special conditions for suspension/cancellation of APRA-supervised entities: ASIC must first consult APRA; for banks the Minister reserves the decision after advice of ASIC. *Assessment: Implemented* - Comments: - ASIC conducted comprehensive relicensing under FSRA 2001: 100 staff processed approximately 4000 license applications in last 18 months; 284 license verification inspections conducted. - Constraints on suspending/canceling APRA supervised entities are consistent with functional regulation but are not reciprocal. Principle 22 — Prudential capital and requirements - Financial requirements: - CA and ASIC PS 166 specify initial and ongoing financial requirements varying by financial services offered; these do not apply to AFSL holders also regulated by APRA. - Licensees may operate under market operator financial requirements if ASIC satisfied they are adequate substitutes. - All licensees subject to base level financial requirements; additional limited risk-based capital requirements where business requires. - Members of ASX subject to comprehensive risk-based capital requirements; most SFE members are banks supervised by APRA. - APRA supervised entities subject to Basel trading book requirements; seven banks authorized to use internal models for market risk calculation. *Assessment: Partly implemented* - Comments: - Base level requirements consistent with international best practice; examples include capital for small-scale financial advisers (sufficient cash to cover next three months expenses) and forward-looking monitoring of cash inflows/outflows for at least next three months. - ASIC’s risk-based requirements do not match international norms: risk element is limited; no provisions covering risks from unlicensed affiliates or off-balance sheet risk (explicit in PS 166 paragraphs 122, 123, 150). - Large entities engaged in high-risk OTC dealing may have lower regulatory capital than in most developed markets. - Trading volume by value in the OTC markets substantially exceeds on-exchange markets: $A 58 trillion versus $A 24 trillion in 2004/5. Principle 23 — Internal organization and operational conduct - ASIC expectations (PS 164): - Adequacy of internal controls. - Measures to identify and manage conflicts of interest, including segregation. - Senior management’s responsibility. - Independent audit of key systems and controls (auditor must report breaches to ASIC). - Safeguarding firm and client assets. - Proper accounting and record maintenance. - Efficient and effective complaint resolution (internal and external independent ASIC-approved mechanism). - Statutory client documents: - Financial Services Guide, Statement of Advice (detailed know-your-customer and suitability requirements), Product Disclosure Statement (except for securities). - Obligation to provide post-transaction confirmations. - Compliance monitoring: - Licensees must maintain comprehensive books and records; ASIC interprets law as requiring persons responsible for monitoring compliance and notifying ASIC of significant breaches. - Unconscionable conduct: - CA (s991A) prohibits unconscionable conduct, providing an additional basis for client recovery. *Assessment: Implemented* - Comments: - Detailed disclosure requirements have increased documentation weight and cost; consumer groups find current documentation lengths unhelpful and possibly camouflaging essential details. - Government introduced refinements to FSRA terms expected to be well regarded. Principle 24 — Failure procedures for intermediaries - Failure and default procedures: - ASIC has contacts and procedures for coordinated response to major market disruptions. - Exchanges (ASX and SFE) perform regular ‘snapshot’ of open positions and assume default procedures. - Insolvency of a licensee gives ASIC grounds to suspend or cancel the AFSL immediately (s915B CA) without hearing. - ASIC can apply to court to freeze or restrict accounts with financial institutions (s983A(3) CA) and seek orders to pay specific amounts to ASIC or its nominee (s983D CA) and distribution schemes (s983E CA). - ASIC can apply to wind up corporation on insolvency grounds (s459P CA) and seek appointment of a receiver (s1323 CA). - ASIC must publish notice of action in the Gazette (in practice on its web site) and notify market operators if licensee is a participant (s915F(2) CA). - Operators have powers under rules to suspend or terminate participants. - Information exchange: - ASIC can exchange confidential information with domestic and foreign entities including licensed market operators, APRA, RBA and government agencies. - SFE default of a U.S.-based broker tested effectiveness of international cooperation arrangements. *Assessment: Broadly implemented* - Comments: - Gap: absence of a general customer compensation scheme covering retail clients of all AFSL holders; licensed market operators required to have such schemes for retail clients of their participants (Minister must approve). - Securities dealers required to post a bond for A$20,000 with ASIC. - A comprehensive scheme expected to change in July 2006 with new regulations under public consultation (likely insurance based). --- ### Principles for the Secondary Market (Principles 25–30) Principle 25 — Authorization and oversight of trading systems and exchanges - Licensing: - Australian Markets License (AML) required to operate a market; Australian Clearing and Settlement Facility License (CSFL) required to operate a clearing and settlement facility. - Power to grant licenses resides with the Minister; ASIC required to give advice. - Key license condition: rules/procedures to ensure market is ‘fair, orderly and transparent’. - Other requirements: adequate investor compensation arrangements, no disqualified person involved, no unacceptable control situation. - PS 172 provides guidance on statutory obligations and information expected from applicants (technology, financial resources, clearing/settlement arrangements, supervision procedures, investor compensation). - Minister may impose, vary or revoke license conditions; all rule changes submitted to Minister via ASIC; Minister has 28 days to disallow rule change. - Market structure: - 14 licensed markets and 4 clearing and settlement facilities (CSF); ASX and SFE each own two CSFs. - ASX has 99 percent of on-exchange equity trading; SFE has similar proportion of on-exchange derivatives trading. *Assessment: Implemented* - Comments: - Suggestion to review Minister/ASIC division of responsibilities; practical practice of negotiating rule changes with ASIC before Minister submission may make process redundant; consideration to transfer licensing to ASIC could simplify licensing. - ASIC monitoring technological trading systems in wholesale OTC markets; has not interpreted definition of financial market to include these systems and relies on AFSL conditions to govern operators; may revise if retail involvement grows. Principle 26 — Ongoing supervision of exchanges and trading systems - ASIC supervision: - AML licensees required to comply with license conditions on an ongoing basis. - ASIC conducts annual assessments of exchange compliance with license terms (on-site and off-site examinations) and publishes assessments. - Assessments are historical and forward-looking with follow-up recommendations. - 2005 report criticized repeated failures and called for substantial improvement in warrants market supervision, addressing inconsistencies in listing rule enforcement, conflicts of interest, and improved derivatives market monitoring. - ASIC entitled to access exchange electronic trading platforms and records and require assistance; MOUs between ASIC and ASX/SFE reflect cooperation and are public. - Minister and ASIC have powers to secure compliance; the Minister can direct AML holders and ASIC can direct an AML to suspend dealings. - Oversight of clearing and settlement: - ASIC shares oversight responsibility with Reserve Bank of Australia (RBA). - RBA issued financial stability standards for CSFL holders acting as central counterparties and settlement facilities (CPSS-IOSCO focus). - RBA focused on payment system issues; ASIC focused on customer-facing issues and investor confidence. *Assessment: Implemented* - Comments: - ASX modernizing supervisory/regulatory functions and improving relationship with ASIC. - ASX migrating SEATS trading platform to OM Group system (previous SFE provider); ASIC monitoring outsourcing compliance. Principle 27 — Transparency of trading - Requirements and practices: - Exchanges must have operating rules addressing execution of orders, recording and effective disclosure of transactions; rules approved by Minister. - Regulatory presumption in favor of high transparency; equality of access to trading information assessed during licensing. - ASX operates a central limit order electronic trading platform displaying bids, offers and executed trades in real time (subject to delays for block trades). - ASX introduced an iceberg facility for trading large blocks on SEATS to encourage on-market block trades. *Assessment: Implemented* - Comments: - Debate on including broker-dealer identity in real-time trade reports concluded with removal of broker IDs for a twelve-month trial period; ASIC did not dissent. Principle 28 — Detecting and deterring manipulation and unfair trading - Prohibitions and enforcement: - Market manipulation, market cornering, insider trading, misleading statements, front running and other fraudulent/deceptive conduct prohibited under Part 7.10 of the CA. - Except for misleading or deceptive conduct (civil liability only), breaches attract both civil liability and criminal prosecution. - Exchanges must notify ASIC of suspected significant contraventions; ASX conducts surveillance on SEATS via SMARTS system. - Exchange sanctions include censure, fining, suspension of membership and expulsion. - ASIC empowered to share confidential information with exchanges; inter-market cooperation arrangements in place. - Continuous disclosure obligations on listed companies imposed by CA and listing rules (cautionary announcements and price sensitive information). *Assessment: Implemented* - Comments: - Continuous disclosure compliance improving but regional variations persist; ASX and ASIC need ongoing pressure on issuers. - ASIC secured 5 criminal convictions and 2 civil penalty orders for insider trading and market manipulation in 2004/5. Principle 29 — Management of large exposures, default risk and market disruption - Clearing and settlement regulation: - License condition requires licensee to have operating rules dealing with default and risk management procedures. - RBA may issue standards to ensure CSFL holders conduct affairs promoting overall stability (s827D CA); standards developed in consultation with ASIC and CSFL holders to ensure finality and irrevocability of settlements. - CSFLs subject to extensive reporting requirements to RBA. - ASIC can direct CSFL holders to adopt measures to comply with RBA standards or reduce systemic risk (s823D CA). - Information exchange arrangements between regulators and CSFL holders comprehensive. *Assessment: Partially implemented* - Comments: - Examples from Australian Clearing House (ACH) rules indicate default rules meet international norms for suspension/cancellation, default and transfer of derivatives CCP contracts. - Gap: no regulations to ensure proper management of large exposures, default risk and market disruption for bilateral transactions involving AFSL holders not supervised by APRA (e.g., underwriting exposures, OTC trading). - Much bilateral business transacted under global master agreements (ISDA) but residual concerns remain. - Assessor views improvements should be made though not necessarily a breach of Questions 2 and 3. Principle 30 — Clearing and settlement systems oversight - Assessment: This Principle has not been assessed - Comments: (no assessment content provided) --- ### Summary implementation metrics (Table 8) - Implemented: 21 principles — 1,3,4,5,6,7,9,10,11,12,13,15,16,18,19,21,23,25,26,27,28 - Broadly implemented: 5 principles — 2,14,17,20,24 - Partly implemented: 2 principles — 22,29 - Non-implemented: 1 principle — 8 - Not applicable: 0 --- ### Recommended actions (selected from Table 9) - Regulator (P1–5): - Consider amending the ASIC Act to remove Minister’s power to give directions and to instruct ASIC to investigate. - Consider reversing dependence on special purpose funding. - Consider funding a proportion of ASIC’s work via a levy on the financial services industry. - Consider measures to improve consultation with the private sector. - Enforcement and tools (P8–10): - Consider removing ambiguities in ASIC’s use of evidence obtained from search warrants. - ASIC should adopt a comprehensive suite of tools for identifying and prioritizing risk in surveillance. - Cooperation (P11–13): - Consider whether ASIC should be authorized to acquire and transmit information directly to overseas counterparts without Attorney General’s permission. - Issuers (P14–16): - ASIC should issue a comprehensive Policy Statement on prospectus disclosure. - Collective Investment Schemes (P17–20): - ASIC should issue a Policy Statement on responsible entity expectations for best execution, timely allocation of trades, prevention of churning, and underwriting agreements. - Market intermediaries (P21–24): - Consider reciprocal constraints when suspending/canceling APRA supervised entities. - ASIC should ensure Australia’s risk-based capital requirements meet international norms. - Secondary market (P25–30): - Consider transferring licensing power for market operators and CSFs to ASIC. - ASIC should ensure risk-based capital requirements take proper account of systemic risks of large exposures in OTC markets. *Italic: Source — _cr06415 - Chapter 6 of the CA contains detailed provisions that implement the Principles. Contravention* ### Introduction ### _cr06415 - Introduction ### Authorities' overall assessment and response - The authorities welcome the comprehensive assessment of Australian securities regulation as part of the IMF’s Financial Sector Assessment Program and consider the assessment reflects a high degree of compliance with the IOSCO objectives and principles of securities regulation. - Australia is already taking steps to implement some recommendations and is carefully considering others to ensure optimal compliance with the IOSCO objectives and principles. ### Independence of the regulator (ASIC) - ASIC has complete independence in relation to the performance of its functions and exercise of its powers under the corporations legislation. - The Australian Government considers that the IOSCO principle on independence: - Requires an additional degree of autonomy in relation to regulatory policies and funding that the Government finds difficult to reconcile with ministerial accountability. - Should be reconsidered by IOSCO to focus on independence in the administration of the regulatory framework as it relates to specific cases, rather than requiring absolute strategic and financial autonomy from the executive arm of Government. - Specific features of ministerial oversight and ASIC autonomy: - The Minister’s power to issue a direction to ASIC with respect to policies and priorities is limited and subject to prerequisites to ensure transparency and accountability. - A direction may not relate to a specific matter. - While the Minister may direct ASIC to investigate a matter, the conduct of the investigation is a matter for ASIC. - ASIC has a high degree of flexibility in regard to the allocation of its funding across priorities. - Cost recovery arrangements that fund ASIC and other elements of the corporations regulation scheme are scheduled for review in 2007. - There is no intent to introduce new levies on corporations. ### Funding of the regulator - The Australian Government emphasizes robust fiscal discipline over the past decade as ensuring adequate funding for government services and agencies while producing sustained fiscal responsibility. - Recent funding increases for ASIC: - In the 2006-07 Budget, ASIC’s funding was increased by approximately 25 per cent, or $234.6 million over four years. - The additional funding will ensure ASIC has sufficient funding to maintain its current regulatory focus, develop its presence in relation to non-exchange based market trading (over-the-counter trading), and provide greater flexibility in funding enforcement activities. ### Improving industry consultation - ASIC released its Better Regulation ASIC Initiatives project in May 2006 to improve engagement with stakeholders and ensure effective and efficient consultation. - Initiatives include: - Establishing a Business Consultative Panel in Sydney and Melbourne. - Designing a standard liaison strategy to apply across the regulated population. ### Information sharing and cooperation - To address timeliness in responding to requests for information from overseas regulators, responsibility for the Mutual Assistance in Business Regulation Act 1992 (MABRA) is being transferred to the Treasury to align the operation of MABRA with the portfolio of regulatory agencies administering the legislation. - The transfer of responsibility is expected to be completed shortly and the new arrangements will be reviewed in due course. ### Enforcement - The Australian Government is considering changes to ASIC’s search warrant powers, consistent with recent changes proposed for the Australian Competition and Consumer Commission. - ASIC is not the regulator of anti-money laundering/counter terrorist financing (AML/CFT) regulation in Australia; the legislation it administers does not give it responsibility in this area. - The definition and regulation of AFSL holders is distinct from how classes of persons are, or are intended to be, regulated under the Australian AML/CFT regulations. - The Australian Government is committed to ensuring proposed enhanced AML/CFT regulatory arrangements are supported by effective co-operation as appropriate between the AML/CFT regulator, AUSTRAC, and both ASIC and APRA. ### Issuers - ASIC is finalising guidance on prospectus disclosure based on the draft policy statement Better prospectus disclosure released for public consultation in February 2006; it is expected the policy statement will be finalised and released in the near future. ### Collective investment schemes - No problems were identified with current regulatory arrangements relating to managers’ conduct when trading on behalf of clients; additional detailed requirements are not justified by a regulatory impact assessment. - Regulators agree monitoring compliance with accurate unit pricing obligations is important. - Continuing work with industry is important to tackle root causes of unit pricing error, often related to reliance on ageing computer software platforms. - Policy work is under way to determine the most effective method to tackle impediments to transferring to modern systems that permit timely and accurate unit price calculations. ### Compensation arrangements - A mandatory requirement for Australian financial services licensees to have appropriate compensation arrangements to meet their obligations under the Corporations Act takes effect on 1 July 2006. ### Reciprocal arrangements between ASIC and APRA - The current arrangement requiring ASIC to consult APRA on the impact of imposition, variation or revocation of an AFSL is considered satisfactory as it relates to consultation by ASIC on the effect on an existing authorisation of an ADI by APRA. - ADI authorisation will necessarily precede an application to ASIC for an AFSL, making a reciprocal consultation obligation on APRA unnecessary. ### Risk-based capital requirements - The Australian Government will consider imposing risk based capital requirements to address systemic risks arising from OTC derivatives trading, as part of ongoing policy oversight of market regulation. ### Secondary market regulation - Under the Corporations Act 2001, the Minister has the power to licence financial markets in Australia. - Before granting a financial market or clearing and settlement facility licence, the Minister is required to consider advice of ASIC and typically departmental advice. - The Minister’s involvement is intended to ensure decisions are taken from a broad public policy position weighing overall benefits and economic impact. - The Australian Government will examine in greater detail the merits of transferring all regulatory powers in relation to financial markets and clearing and settlement facilities to ASIC before making any decision to change current arrangements. ### CPSS — Core Principles for Systemically Important Payment Systems (overview) - The assessment of payment systems in Australia was undertaken in the context of the IMF FSAP exercise for Australia in December 2005 and covers the Reserve Bank Information and Transfer System (RITS), which settles transactions on a real time gross settlement (RTGS) basis. - RBA conducted a comprehensive self-assessment of RITS’ observance of the Core Principles for Systemically Important Payment Systems (CPSIPS) and the material was provided to the mission in advance. - The assessment methodology derived from the Guidance Note for Assessing Observance of Core Principles for Systemically Important Payment Systems of the IMF and the World Bank of August 2001; RBA prepared a self-assessment and filled in the Questionnaire on Payment and Securities Settlement Systems. ### Institutional and market structure for payments - Key institutions and roles: - Reserve Bank of Australia (RBA): central bank operating under the Reserve Bank Act 1959 and the Payment Systems (Regulation) Act 1998; payments policy and oversight determined by the Payments System Board (PSB). - Payments System Board (PSB): chaired by the Governor of the RBA; composed of one RBA appointee, an appointee from the Australian Prudential Regulation Authority (APRA) and up to five other members; mandate set out in the Reserve Bank Act. - Payments Policy Department: implements PSB policies and advises the PSB. - Australian Prudential Regulation Authority (APRA): supervises deposit-taking institutions participating in the payments system. - Australian Securities and Investments Commission (ASIC): responsible for market integrity and consumer protection across the financial system, including payments transactions; administers the Corporations Act 2001 and regulates corporations, financial markets, clearing and settlement facilities (in conjunction with the RBA), and financial service providers. - Australian Competition and Consumer Commission (ACCC): ensures payments system arrangements comply with competition and access provisions of the Trade Practices Act 1974 and can exempt conduct if judged in the public interest; ACCC and RBA have a Memorandum of Understanding. - Australian Payments Clearing Association (APCA): administers SWIFT payments and coordinates clearing of most retail payment instruments; APCA is a limited company owned by shareholders including banks and the RBA. Other clearing systems include MasterCard, Visa, Bankcard, and the BPAY system. ### Payment systems infrastructure (RITS and retail payments) - RITS specifics: - Introduced as an RTGS system in June 1998; owned and operated by the RBA. - Processes and settles transactions continuously and irrevocably in real-time; accepts payment instructions for interbank payments and settlement of net clearing arrangements; also handles low value transactions. - Final settlement is executed by entries to participants’ exchange settlement accounts (ESA) at the RBA. - The bulk of large value interbank transfers is channeled through the SWIFT network, with a smaller number transmitted via proprietary network infrastructure. - RITS accepts settlement for interbank obligations from net clearing arrangements (next day basis) and settles the cash leg of Austraclear securities transactions on a real-time gross basis. - There is no minimum payment amount for RITS; it handles time-critical low-value and large-value payments. - In 2005, RITS had 60 participants and on average settled 24,000 transactions daily with an average daily value of $A 150 billion. - Payment flows in RITS are concentrated: the four major banks have 67 percent of the volume and value of total RTGS transactions. - No bank acts as a major settlement agent for other banks; agency arrangements account for less than 1 percent by value of transactions. - Retail payment instruments and usage: - Cash remains most important for small retail transactions and transfers between individuals; ATM availability sustains cash use. - ATM withdrawals average $A 10.9 billion a month in 2004-2005, equating to around $A 540 per person. - Non-cash payments account for most of the value of payments in the Australian economy: on average, non-cash payments worth more than $A 170 billion are made each business day, equivalent to about 20 percent of GDP. - Check payments account for around 5 percent of the value of non-cash payments; use of checks is lower than in the United States and continental Europe but higher than in Scandinavian countries. - Electronic retail payment usage is growing rapidly: - Credit and debit card transactions averaged 112 per person in 2004-2005. - Direct entry payments are growing strongly and account for about 15 percent of the value of non-cash payments. - The electronic retail payment infrastructure is highly developed and appears efficient for users, though relatively costly. - Most banks charge a “foreign fee” averaging $A 1.50 per transaction when using another bank’s ATM; transaction fees for payment cards for EFTPOS transactions have fallen in recent years. ### Participation and policy on RTGS access - Banking and participation statistics: - 25 locally-owned banks, 28 branches of foreign banks, and more than 150 credit unions are active in Australia. - 53 banks and branches are participants in RITS. - Policy on participation: - RBA preferred broad participation in RTGS to reduce risk concentration and, as policy, required banks to make their own high value payments using their own central bank account. - Policy was relaxed in March 2003 to allow very small central bank account holders (less than 0.25 percent of total payments) to enter into agency relationships with other participants. *Italic: Source — _cr06415 - Introduction (extracted content).* ### 86. The Reserve Bank Act and the Payment Systems (Regulation) Act empower the RBA ### _cr06415 - 86. The Reserve Bank Act and the Payment Systems (Regulation) Act empower the RBA ### Legal basis and enforceability (CP I) - Framework legislation and instruments: - The Reserve Bank Act 1959 establishes the Payments System Board (PSB) of the RBA, which determines the RBA’s payments system policy to "best contribute to, inter alia, controlling risk and promoting efficiency and competition". - The Payment Systems (Regulation) Act 1998 gives the RBA powers to designate a payment system, obtain information from participants, set access regimes and determine risk control and efficiency standards; it allows consideration of efficiency and competitiveness in determining the public interest. - The Payment Systems and Netting Act 1998 allows the RBA to provide legal certainty in approved RTGS payment systems for transactions on the day of appointment of an external administrator and gives legal certainty to approved multilateral netting arrangements. - The RITS Regulations and Conditions of Operation and associated contractual agreements set out RITS operational rules and the rights and obligations of participants and the RBA; Part 24.10 submits parties to the non exclusive jurisdiction of the courts of New South Wales and courts of appeal from them. - The Cheques Act 1986 establishes the framework for checks; amended in 1998 to allow nonbank authorized deposit-taking institutions to issue checks; allows turn-back/presumed dishonor for failed drawee institutions. - The Trade Practices Act 1974 contains provisions relevant to restrictive trade practices and consumer protection; the ACCC may authorize conduct judged to be in the public interest; APCA clearing stream regulations/procedures have been authorized by the ACCC. ASIC has consumer protection powers under the Trade Practices Act. - Enforceability of laws and contracts: - All relevant laws and contractual arrangements within the RITS framework are fully enforceable. Each RITS member signs a contract binding the participant to the RITS Regulations; the RITS Regulations can be enforced through legal action. - Irrevocability and finality: - The Payment Systems and Netting Act provides legal certainty for approved RTGS transactions. Payment instructions in RITS can be revoked by the participant until settlement is executed; from that moment the payment is irrevocable and cannot be reversed by any party. Finality occurs at the moment the payee bank’s account is debited and, as defined by the system, the receiving bank’s account is simultaneously credited. - Netting and zero-hour rules: - RITS is an RTGS system and netting does not occur; Part 3 of the Payment Systems and Netting Act protects approved netting arrangements and Part 4 protects close out netting. - The Payment Systems and Netting Act allows protection of transactions in approved RTGS systems from the potential application of the zero-hour rule; RITS is an approved RTGS system in terms of Part 2 of this Act. - Collateral and intraday liquidity arrangements: - The RBA accepts only repurchase agreements (repos) as a mechanism to provide intraday liquidity to the system. These repos are governed by the PSA/ISMA Global Master Repurchase Agreement (1995 version) as amended in exhibits under the RITS Regulations. - Electronic processing and other laws: - The Electronic Transactions Act 1999 provides a legal framework for electronic signatures, electronic record maintenance and giving information electronically. - The Banking Act 1959 covers legal requirements to be an authorized deposit-taking institution. - The Corporations Act 2001 includes provisions dealing with insolvency; the Payment Systems and Netting Act 1998 addresses problems of the “zero-hour rule”. Corporations law reforms established licensing for clearing and settlement facilities and empowered the RBA as overseer for financial stability aspects. - Relevance of foreign laws: - RITS is regulated under Australian law; an overseas court order is not enforceable in Australia. Nonresident participants can access RITS via an Australian branch or remotely; contractual obligations require nonresidents to submit to New South Wales law. The Corporations Act requires Australian courts to act in aid of courts of prescribed foreign countries (including Canada, Malaysia, Papua New Guinea, Singapore, Switzerland, the U.K. and U.S.A.), but does not allow unwinding transactions in RITS. - Assessment: - Observed. Comment: The operations of RITS and payment transfers through the system have a sound and solid legal basis. - Recommendation: - Entities located outside the Australian jurisdiction that apply for participation in RITS either as a branch or on a remote basis should be required to provide a legal opinion that analyzes possible conflict of laws and potential legal risk to RITS and its participants. ### Rules, participant understanding, and disclosure (CP II) - Documentation and communication: - The RITS Regulations and Conditions of Operation identify obligations and rights, operating arrangements and hours. User Guides provide detailed information on RITS features and functions; changes to Regulations are circulated to all members and notified electronically through email. - An Information Paper preceding the RITS Regulations describes the queuing mechanism, the auto-offset facility, transaction statuses, and settlement sessions (daily settlement, evening, morning, interim, close). - Training and testing: - The RBA provides training to all new RITS members, offers refresher training periodically, and grants access to a test environment prior to going live. - Risk management and procedures in rules: - Insolvency of a participant results in suspension of ESA and RITS membership; previously settled transactions are protected by approval under the Payment Systems and Netting Act. - Settlement funds are held in Exchange Settlement Accounts (ESA) at the RBA; ESAs cannot be overdrawn. - Liquidity risk is mitigated via the queue design, bilateral offset, and intraday liquidity provision by intraday repurchase agreements; no cap on intraday liquidity other than value of eligible securities. - The RBA offers an Overnight Repurchase Agreement Facility to enable ESA holders to obtain liquidity overnight; any change to RBA liquidity policy or eligible securities is announced by media release and on its website. - Assessment: - Observed. Comment: Contractual arrangements, documentation, and RBA publications enable participants to understand the system’s impact on each financial risk borne through participation in RITS. ### Credit risk and liquidity risk management (CP III) - Credit risk management: - RITS is an RTGS system settling in central bank money with immediate finality; participants are protected against credit risk because transfers settle by funds held in ESAs at the RBA and ESAs cannot be overdrawn. The RBA is also protected against credit risk. - Y-copy message flow via SWIFT notifies receivers of due payments still held in sender queues; a residual credit risk can arise if a participant makes irrevocable out-payments based on payments blocked in other participants’ queues and those payments are later cancelled, but this risk is described as negligible under normal circumstances. - Queuing, offsetting, and liquidity measures: - The queue uses a liquidity efficient “next-down looping” algorithm with a bilateral auto-offset mechanism. Participants can reprioritize payments by setting statuses: ‘deferred’, ‘active’ or ‘priority’. Active/priority payments are tested for settlement; active payments will be processed unless they would cause the ESA balance to fall below a member-specified sub-limit. - Bilateral auto-offset simultaneously settles offsetting transactions queued for over a minute. Payments not settled at the end of the day are automatically rejected and must be resubmitted the following day. - Intraday liquidity is provided by intraday repurchase agreements on eligible high credit quality securities; no overall cap on liquidity other than eligible securities value. In unusual circumstances intraday repos can be converted to overnight repos by agreement; the interest rate is 25 basis points above the cash rate. - Indicator values: the daily settlement value in RITS averaged $A 150 billion in 2005, and the total liquidity need was around AUD 8 billion. - Information and monitoring: - Participants have real-time access to queue and ESA balance information via RITS terminals and via SWIFT messages using the Automated Information Facility (AIF). AIF allows commands to change payment status or sub-limits, enquiries, and receipt of advice. - Liquidity and settlement are monitored by Domestic Markets Department and Payments Settlements Department in real time; staff coordinate throughout the day. - Throughput and crisis procedures: - The RBA does not use throughput guidelines or price incentives; throughput is monitored and participants occasionally advised about problematic payment patterns. - Crisis Management Group (CMG) can be convened by assistant governors to diagnose liquidity problems; CMG consists of the governor, deputy governor and assistant governors. Coordination with APRA is ensured under a Memorandum of Understanding; Commonwealth Treasury and the Treasurer’s Office will be informed as developments require. - Assessment: - Observed. Comment: RITS design and functionalities protect participants against credit risk and enable appropriate liquidity risk management. ### Finality and settlement timing (CP IV) - Irrevocability and finality: - RITS provides real time immediate settlement finality. Once a payment is settled (simultaneous debit and credit of ESAs) it is irrevocable, unconditional, and cannot be reversed by sender or third party. Until settlement, the sender can recall the transaction. - Finality is enforced and protected under the Payment Systems and Netting Act; it cannot be challenged if the sending bank is declared bankrupt or placed under public administration. - Interval and rejection: - As an RTGS system, payments are settled during the day in real time; unsettled end-of-day payments are removed from the queue and must be resubmitted the following day. - Payments are validated before acceptance into the queue; RITS regulations permit the RBA to reverse any erroneous entry in an ESA. - Operating hours and session extensions: - RITS standard settlement hours are 07:30 to 18:30 in Australian standard time (April to October) and from 07:30 to 20:30 in Australian summer time (November to March). Members can download reconciliation reports for a further 30 minutes after close. - The RBA may vary operating hours under Regulations 5.6 and 5.7; Guidelines for Session Extensions outline procedures for extension requests, judged against objective criteria and approved by Senior Management or duty managers. Records of extensions are kept. - Assessment: - Observed. Comment: RITS provides prompt final settlement during the day; operating times are clearly defined and monitored. ### Settlement assets (CP VI) - Settlement asset: - RITS settles in central bank money; settlement assets in RITS are claims on the RBA executed by debiting the sending participant’s ESA and crediting the beneficiary participant’s ESA. - Participation policy and agents: - Historically the RBA required banks to make high value payments in RTGS using their own ESA to avoid concentration; policy relaxed in March 2003 to allow very small ESA holders (less than 0.25 percent of total payments) to enter into agency relationships. Banks using an agent must hold an ESA for contingencies; very few banks use agents. - Assessment: - Observed. Comment: Settlement in central bank money eliminates settlement bank or deposit risk; credit risk from settlement agents is deemed negligible due to lack of concentration. ### Security, operational reliability and contingency (CP VII) - Security policy and standards: - RBA defines security policies, reliability requirements, and operational service level. RITS is a stand-alone module being redeveloped to a web-style GUI. The RBA benchmarks against BSI 7799:1999 and ISO 9364. - Monitoring and audits: - Regular security risk analyses are conducted. RITS Helpdesk monitors system activity at a minimum every 15 minutes using automated tools and manual checks. Incidents and disruptions are logged; a daily Security Audit Report is produced and examined by Security Group analysts. Quarterly internal reports on performance and service levels are sent to senior management. - Documentation and incident database: - System incidents database records source, description, solution, downtime and impact on RITS sessions. RITS has not experienced any major incident; the number of total incidents is relatively low. - Contingency and backup facilities: - Payments Settlements Department and Systems and Technology Department have agreed service level expectations for production and test environments at primary and backup sites. The RBA’s contingency plan addresses software/hardware defects, telecommunications and power disruptions, staff inability to reach primary site, and disruptions in contact with external parties. Roles and decision-making procedures are documented. - Backup site details: - The backup site has the same capacity and components as the primary site; primary site requires full redundancy. The backup site is located over 20 kilometers from the primary site and uses a different electricity grid and telecommunications exchange. The secondary site will be moved to another location 25 kilometers away from the primary site. - The backup site is a ‘hot backup’ mirroring production transactions in real time so loss of transaction data cannot occur. - In the event of a component failure at the primary site, recovery should be within 15 minutes. If unrecoverable at the primary site, the benchmark time for full recovery at the backup site is within 40 minutes from the time the decision is taken. If relocation of staff to the backup site is necessary, full recovery should take no more than 60 minutes. - Availability statistics: - Average annual availability of RITS (all components): 99.98 percent for 2002, 99.91 percent for 2003, and 99.94 percent for (text ends). - Assessment: - Observed. Comment: The system ensures a high degree of security and operational reliability and has contingency arrangements to enable timely completion of daily processing. *Source: _cr06415 - 86. The Reserve Bank Act and the Payment Systems (Regulation) Act empower the RBA* ### 2004. At no time during recent years was the entire RITS facility unavailable for its ### _cr06415 - 2004. At no time during recent years was the entire RITS facility unavailable for its ### Operational reliability and contingency testing - The RBA conducts an extensive range of contingency exercises to test RITS under different circumstances, aiming at conducting a minimum of four weekend tests each year, simulating a range of hardware or communication failures. - Contingency tests address recovery arrangements for: the RITS computers, the CSI computers, and the communication network. - Contingency tests are extensive and performed on weekends so that the production environment can be used. - New ESA holders must satisfy the RBA of their operational capacity; Payments Settlements Department undertakes an operational readiness assessment prior to “go live,” covering backup capacity. ### Communication networks and data protection - Two communication networks transmit payment orders to the RTGS system: SWIFT network and RITS network. - About 65 percent of transactions are transmitted to the RTGS system using the SWIFT Y-copy services. - Use of the SWIFT network for payments is administered by the Australian Payments Clearing Association (APCA); centralized technical infrastructure is located at the RBA. - The second network is the Austraclear National Network Infrastructure (ANNI); at present, there is no network encryption, although it is a closed network. - As part of the Public Key Infrastructure (PKI) project, a new RITS Security Policy will address encryption and security. - RITS user interface enhancements and a move to digital certificates provide higher levels of system security. - As part of the UI project, Secure Sockets Layer (SSL) technology is being implemented to provide “end-to-end” encryption of online traffic. - Australia does not use the IBAN system for bank account numbering. ### Audit trails, logging and enquiry - All transactions in RITS can be traced end-to-end from recipient to sender; each transaction has a unique transaction ID number. - RITS logs the progress of transactions at each status change in the transaction life cycle. - The system log, updated in real time, includes information on when a transaction is entered, any changes to details or status, rejections, queue status information and settlement details (or removal from the queue at end-of-day). - RITS provides extensive online enquiry audit trails for transaction activity for the last five business days. - A range of reports are available in real-time or as outputs from overnight batch processing. ### Development, change management and procurement - Rigorous measures protect the quality of new software development and testing of updates/releases; a comprehensive change management program is employed. - All changes require user testing and signoff; changes are assessed for effort, impact, risk, complexity, testing requirements and back-out options prior to approval. - All changes must be approved by authorized senior officers before implementation. - Changes pass through a variety of test environments before production implementation. - The RBA has a general guideline that there should be no more than four major change windows each year for RITS. - All RITS-specific changes are discussed and endorsed at a monthly meeting; a weekly change management meeting reviews scheduled and planned system changes. - Exception rules exist for emergency changes. - A software product is used to track changes to RITS-specific components. ### Availability, scalability and capacity - RITS has sufficient capacity to handle significant increases in volumes/activity; required capacity is set out in a Capacity Plan. - Capacity and performance tests are conducted prior to any system upgrade. - The system has sufficient capacity to handle high volumes during peak times; currently, the system uses around 35 percent of its capacity. - RITS has not encountered any capacity constraints; throughput guidelines are considered unnecessary. ### Audits and risk oversight - Regular internal audit reviews and operational inspections review conformity to confidentiality, integrity, authentication, non-repudiability, availability and auditability. - A Risk Management Unit was recently established to ensure a consistent framework for definition, assessment and monitoring of risks. - Both Audit Department and the Risk Management Unit receive copies of Incident Reports following interruptions to RITS service; regular updates on action items are provided. - External security reviews of internal systems and network are conducted annually. - The last independent external audit concluded in January 2005 and focused on the security of the new user interface infrastructure; prior audit of firewall infrastructure concluded in October 2004. - According to the RBA, all major issues raised (with the exception of the network encryption) have been adequately addressed; network encryption is being introduced with the GUI interface. ### System functionality, liquidity and processing performance (CP VIII) - RITS provides standard RTGS facilities: sending, queuing, inquiry, and an offsetting mechanism to promote throughput and resolve gridlocks. - Provision of intraday liquidity by the RBA is unrestricted (based on repo transactions) and is not subject to any charge or fee. - RITS standard settlement hours: - 07:30 to 18:30 in Australian standard time (April to October) - 07:30 to 20:30 in Australian summer time (November to March) - Session extension requests are judged against objective criteria — the outstanding transactions must have an aggregate value of at least $A 100 million. - The RBA may extend operating times if required by Domestic Markets Department. - Processing speed: the Payments Settlements Department monitors settlement time; currently settlement time is not a constraint and capacity is not a restraint on processing speed. - In 2005, around six payments per second were settled each day in the first 15 minutes of the daily settlement session; the highest volume settled in this time slot in 2005 was nearly double, at 11 payments per second. - A range of performance tests are conducted following significant upgrades to ensure throughput requirements continue to be met. ### Cost recovery and pricing - RBA objective is operational cost recovery, currently met by a flat transaction fee. - RBA charges a flat fee per transaction, but no joining or annual fee. - RITS participants pay $A 0.88 for each debit and credit to their ESA (i.e., each transaction incurs a fee for the sender and the receiver). - The reason for charging both sender and receiver is that both receive a benefit from timely, low-risk settlement. - The price structure has not been amended since the launch of RITS in 1998 while the number of transactions has almost doubled. - The RBA has undertaken studies of RITS costs and pricing structure (operating, development and overhead costs) but there have not been formal consultations with users. ### Access, participation criteria and technical requirements (CP IX) - To participate in RITS, a participant must be qualified and have an ESA at the RBA. - Two broad eligibility criteria for an ESA: - the applicant must be a provider of payment services with a need to clear obligations with other providers; and - the applicant must demonstrate they have the liquidity to meet settlement obligations under routine conditions, seasonal peaks and periods of stress. - Institutions authorized and supervised by APRA are eligible for an ESA without special conditions but must demonstrate operational, capacity and liquidity adequacy. - Entities not authorized and supervised by APRA must demonstrate operational capacity and adequate liquidity and may be subject to ongoing collateral requirements. - All ESA holders must be members of RITS and meet operating conditions and charges. - Non-bank ESA holders and most banks are direct participants; ESA holders with relatively small RTGS transaction values may apply to use an agent. - For a bank to use an agent bank, its RTGS transactions must, on a consistent basis, account for less than 0.25 percent of the total value of all RTGS transactions. - Banks that elect to settle through an agent must still maintain an ESA for contingency use. - Prior approval from the RBA and APRA is needed to use or act as an agent. - Technical access requires RITS terminal access to monitor settled payments, ESA balance, manage queued payments and enter cash transfers. - Network access options: dial-up modem or leased line; dial-up is cheaper and more suited to low-volume users; in the future, dial-up access will be replaced by internet connection. - No membership fees; flat settlement cost does not differentiate between low or high volume participants. - Exit rules: a member may resign by giving the RBA one month’s notice in writing (or shorter with RBA agreement); the RBA may terminate or vary membership terms at any time. ### Governance, consultation and central bank responsibilities (CP X and CPSIPS) - RITS is owned and operated by Payments Settlements Department as a functional area of the RBA; Payments Settlements Department reports to the Assistant Governor (Business Services). - Major decisions requiring significant expenditure or policy implications are considered by the RBA’s Executive Committee. - Decisions concerning RITS operation and ESAs are consistent with policy determined by the Payments System Board (PSB). - When RTGS was introduced the RBA advised participants that fees would be capped for five years; the RBA’s goal was to recover external development costs and on-going operational costs in the first five years; internal development costs were not to be recovered by RTGS transaction fees. - The RBA’s website and annual report provide descriptions of RITS and payment policy objectives; the RITS terminal can alert members to operational changes. - Major decisions are made by the RBA and implemented in consultation with participants, typically through informal liaison; participants are not formally involved in decision making. - Consultation responsibility lies with Planning & Client Relations Section of Payments Settlements Department; operational/technical working groups are formed for specific projects. - Participants’ issues concerning SWIFT payments can be discussed within APCA Management Committee 4; participants’ voting rights in that forum are based on volumes transacted; the RBA has a seat on the committee. - Payments Policy Department undertakes ongoing oversight of RITS (including risks, market behavior, costs and fees) and has conducted a comprehensive assessment presented to the PSB. - Payments Policy Department has about 30 staff members. - The Reserve Bank Act 1959 defines RBA’s mandate, including efficiency of payment systems, competition in payment services, and controlling risk in the financial system; the PSB determines payment system policy. ### Assessment conclusions (observed) - The RBA has rigorous and comprehensive security policy measures and procedures to ensure high operational reliability. - RITS provides a reliable service that appears to fit user needs and fulfils public interest by reducing systemic risks and offering an efficient channel for monetary policy execution. - Access rules for RITS are clear, publicly disclosed, fair and objective and do not have a restrictive impact on competition. - RITS’ governance arrangements are effective, accountable, and transparent. - The RBA has appropriate separation between payments policy and operations at the departmental level, but this arrangement raises potential for conflict of interest since issues to be presented to the PSB are first discussed by a committee of RBA executives chaired by the PSB chairman. ### Recommended actions (selected, verbatim recommendations) - Require entities, located outside the Australian jurisdiction, that apply for participation in RITS either as a branch or on a remote basis to provide a legal opinion that analyzes possible conflict of laws and potential legal risk for RITS and its participants. (Legal foundation - CP I) - Require security enhancement of the proprietary communication network to meet international standards with regards confidentiality, integrity and authenticity of the transmitted information and data. (Security and operational reliability, contingency arrangements - CP VII) - Consider an external review of the RBA’s business continuity plan that would include assessment of the hardware, software and internal procedures. (CP VII) - Consider following up its studies of RITS costs and pricing structure by consulting RITS users; consider a review of the pricing structure to ensure it promotes efficient functioning of the system. (Efficiency and practicality - CP VIII) - Consider establishing a consultative framework with users (re-establish advisory user groups) representing different categories of RITS participants to discuss technical and business features. (Governance - CP X) - Consider whether current arrangements avoid potential conflicts of interest between the PSB’s policy/oversight functions and the Bank’s role as operator of RITS; strengthen PSB oversight by developing formal methods and procedures, including regular monitoring and reporting, on-site inspections and regular meetings with payment system providers. (Central Bank Responsibilities) ### Authorities’ response (summary of actions and intentions) - Authorities concur that RITS complies with all Core Principles and that oversight arrangements comply with central bank responsibilities. - An upgrade to the RITS user interface was well advanced at the time of assessment and is due for implementation during 2006; this upgrade will bring confidentiality, integrity and authenticity of transmitted information up to best practice. - During 2006, the Reserve Bank will finalize a review of pricing and will take into account cost recovery, system efficiency, appropriate incentives and industry feedback. - The Bank will continue to ensure appropriate delineations between oversight and operational functions and will ensure that any conflicts of interest in the oversight process are properly addressed. - The Reserve Bank will give careful consideration to IMF recommendations on legal risk from branch participation in RITS, external review of the RITS business continuity plan, and arrangements for consultation with RITS users; the Bank will consider how best to perform its oversight function. *Source: IMF assessment chapter on RITS (content unit _cr06415).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06415.pdf_