House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Treasurer, the Hon Wayne Swan Mp

Chapter 5

Other measures : banking

Outline of chapter

5.1 Schedule 2 of the Bill amends the Banking Act 1959 (Banking Act) primarily to expand and enhance the duties, powers and functions of ADI statutory managers.

Context of amendments

5.2 APRA already has the power to become or appoint a statutory manager of an ADI under the Banking Act. A statutory manager replaces the board of the institution and has all the powers and functions of the board of directors of the distressed ADI.

5.3 At present, the underlying rationale in the appointment of ADI statutory managers is for them to act in the interests of depositors. When performing their functions for a financial institution, statutory managers should also have regard to the need for financial system stability, because of the economic significance of these institutions and the potential effects of their failure on economic and social stability.

5.4 The powers in the Banking Act for managing a distressed ADI are generally drafted as high-level principles, intended to allow APRA and a statutory manager to act in the interests of the ADI's depositors. However, the Corporations Act, Australian Securities Exchange (ASX) listing rules and the company's constitution currently limit a statutory manager's ability to deal with the share capital of an ADI. Restrictions on the statutory manager's powers may frustrate options for the resolution of financial institution distress.

5.5 Ministers have inherent powers to enter into contracts or arrangements, but the present need to obtain an appropriation prior to making payments under such arrangements may inhibit the Government's ability to act quickly in some circumstances.

Summary of new law

5.6 If an administrator of an ADI believes that a proposed course of action is likely to have a detrimental effect on financial system stability in Australia, the administrator must notify APRA and obtain APRA's consent before acting, unless it is not reasonably practicable to do so.

5.7 Terms in contracts including those made under the law of a foreign country that are enforceable in Australia relating to the appointment of a statutory manager or the use of APRA's directions powers are not grounds for a contract or a counterparty to deny obligations, accelerate debt or close out on any transaction under that contract.

5.8 In order to facilitate earlier and more effective intervention where necessary, the circumstances for commencement of statutory management or investigation have been broadened to include where APRA considers that in the absence of external support: the ADI may become unable to meet its obligations; the ADI may suspend payment; or, it is likely that the ADI will be unable to carry on banking business in Australia consistently with the interests of depositors or financial system stability in Australia.

5.9 A statutory manager has powers to facilitate a recapitalisation through: issuing new shares or rights to acquire shares; selling those shares or rights; cancelling existing shares or rights; or varying or restricting rights attached to shares. A statutory manager also has powers to amend governance arrangements of an ADI. These powers override any potential restrictions in the Corporations Act, contracts, listing rules and company constitutions.

5.10 A person who proposes to appoint an external administrator to an ADI must give prior notice to APRA. A liquidator of an ADI that proposes to apply to Court in relation matters arising under the winding up must give prior notice to APRA.

5.11 The Minister may, with the written approval of the Finance Minister, authorise the making of contracts or arrangements for the main purposes of the Banking Act - that is, to protect the interests of depositors and financial system stability in Australia. Amounts up to a cap can be appropriated for making payments under such contracts or arrangements under the Banking Act, Insurance Act and Life Insurance Act.

Comparison of key features of new law and current law

Detailed explanation of new law

Duties of administrator of ADI's business

5.12 An administrator of an ADI's business must advise APRA if they have reasonable cause to believe that the exercise of a function or power by them is likely to have a detrimental effect on financial system stability in Australia. [Schedule 2, Item 14, Section 14DAA(1)]

5.13 An administrator will not be able to exercise a function or power that may have a detrimental effect without receiving APRA's consent. This consent must be in writing, to ensure it is clear whether APRA has consented.

5.14 These additional duties are qualified to take into account circumstances where it may not be reasonably practicable for an administrator to meet its obligations, particularly if an action is urgent. However, there is an expectation that the administrator will advise APRA as early as possible of the action. [Schedule 2, Item 14 Section 14DAA(2)]

5.15 Subsection 8(2) of the Australian Prudential Regulation Authority Act 1998 provides that one of APRA's purposes in performing and exercising its functions and powers is to promote financial system stability in Australia. Further, subsection 12(1) of the Banking Act requires APRA to exercise its powers and functions for the protection of the depositors of the several ADI's and for the promotion of financial system stability in Australia.

5.16 The general requirement for APRA's prior consent to a proposed course of action will help avoid actions that may have a detrimental impact on financial system stability.

5.17 An administrator's failure to comply with these requirements will not invalidate their performance of a function or exercise of a power. [Schedule 2, Item 14, Subsection 14DAA(3)]

5.18 The above requirements apply to administrators appointed on or after commencement. [Schedule 2, Item 15]

No ending of contracts on directions or appointment of ADI statutory managers

5.19 ADIs are parties to contracts that allow them to participate in markets and access systems that are necessary for their operations. These contractual arrangements could include clauses that allow a counterparty to terminate the contract and demand immediate payment of amounts owed under the contract in circumstances, such as where a statutory manager is appointed or APRA issues directions to the institution.

5.20 For example, the Australian Payments Clearing Association regulations deem the appointment of a statutory manager an insolvency event, while the International Swaps and Derivatives Association master agreement contains clauses that make the appointment of a statutory manager a defaulting event.

5.21 The operation of such contractual provisions would significantly affect an already weak ADI.

5.22 The Banking Act already specifies in sections 11CD and 15C that the appointment of a statutory manager or use of APRA's directions powers is not grounds for the counterparty to deny any obligations, accelerate any debt or close out on any transaction under a contract. The relevant provisions are silent on whether they apply to contracts governed by Australian law or the law of a foreign country.

5.23 The provisions are amended to make clear that they apply to whether the contract is governed by Australian law (including the law of a State or Territory) or the law of a foreign country, or part of a foreign country. The use of APRA's directions powers or the appointment of a statutory manager to an ADI is not grounds for the contract or the counterparty to the contract to deny obligations, accelerate any debt or close out on any transaction under a contract. [Schedule 2, Items 4, 5, and 18, Sections 11CD and 15C]

5.24 Similar provisions to the above are also included where a statutory manager exercises recapitalisation powers (see below). [Schedule 2, Item 12, Sections 14AC]

5.25 These amendments apply to contracts made after commencement. [Schedule 2, Items 6, 13 and 19]

5.26 Currently, under section 15B of the Banking Act, appointing a statutory manager ceases all legal proceedings against the ADI, or in relation to the ADI's property, except where the APRA or Court has consented otherwise. It also prevents any person commencing new proceedings unless APRA or Court consents. An amendment to this section will clarify that this moratorium does not apply to criminal proceedings or civil penalty proceedings. This ensures that law enforcement can continue during statutory management, and is similar to the exemption for criminal proceedings and prescribed proceedings under section 440 of the Corporations Act. [Schedule 2, Items 17, Subsection 15B(1A)]

Commencement of ADI statutory management

5.27 Under subsection 13A(1) of the Banking Act, subject to certain conditions, APRA may investigate the affairs of an ADI, take control of an ADI's business or appoint a person or administrator to perform these roles. An entity that takes control of an ADI under the section - either APRA or an administrator appointed by APRA - is referred to as an ADI statutory manager.

5.28 Existing paragraph 13A(1)(b) of the Banking Act, which allows for statutory management or investigation where APRA considers that the ADI is likely to become unable to meet is obligations or that it is about to suspend payment, may be interpreted narrowly to imply that statutory management or investigation can only commence just prior to an imminent failure.

5.29 As interventions at an earlier stage may be more effective in some circumstances, paragraph 13A(1)(b) is amended in order to broaden the range of circumstances where a statutory manager or investigator can be appointed by APRA (or where APRA can commence performing these roles itself).

5.30 Paragraph 13A(1)(b) is amended so that APRA may act where it considers that in the absence of external support: the ADI may become unable to meet its obligations; the ADI may suspend payment; or, it is likely that the ADI will be unable to carry on banking business in Australia consistently with the interests of depositors or financial system stability in Australia. [Schedule 2, Item 7, Paragraph 13A(1)(b)]

5.31 Excluding external support from the condition is necessary in order to ensure statutory managers can be appointed despite the existence of arrangements such as the Government's guarantee of deposits under Schedule 1 Part 1 of the Banking Act.

5.32 The concept of external support can be clarified by regulations that specify a form of support for an ADI that that is not to be considered to be external support for the purposes of paragraph 13A(1)(b). [Schedule 2, Item 8, Subsection 13A(1A)] Initially it is envisioned that the regulations would exclude forms of support that are entered into in the normal course of business and industry support contracts certified by APRA under section 11CB of the Banking Act.

5.33 APRA must give the ADI notice that an ADI statutory manager will take, or is taking, control of the business. This is intended to allow APRA to specify a time at which statutory management commences in the notice. Statutory management commences at the time specified, or if no time is specified, at the time the notice is given. [Schedule 2, Item 9, Section 13BA]

5.34 The requirement to give notice applies to decisions to take control of an ADI's business made after commencement. [Schedule 2, Item 10]

5.35 APRA continues to have regulatory powers in relation to the ADI, which ensures the ADI is subject to ongoing prudential regulatory scrutiny while it is under statutory management. The provisions of the Banking Act and the Financial Sector (Collection of Data) Act 2001 continue to apply. [Schedule 2, Item 18, Section 15D]

5.36 This means the ADI under statutory management is still required to comply, as far as possible, with the prudential framework including capital adequacy and reporting requirements. APRA however also already has powers that could be used to exempt a specified person from specific requirements of the Banking Act. This power may be used to exempt the ADI from some prudential requirements, such as capital adequacy requirements, while the statutory manager is in control of the entity and is considering an appropriate course of action.

Powers of ADI statutory managers to facilitate recapitalisation

5.37 The recapitalisation of a financial institution is an internationally recognised method of resolving a failure and restoring the institution's health. Capital provided to a distressed institution provides a cushion to support any losses and it enhances its ability to operate competitively in the market. Importantly, it does not impose a repayment obligation on an already weak institution.

5.38 An ADI statutory manager may facilitate a recapitalisation through: issuing new shares or rights to acquire shares; selling those shares or rights; cancelling existing shares or rights; or varying or restricting rights attached to shares. The statutory manager could also reduce the company's share capital by cancelling any paid-up share capital that is not represented by available assets. [Schedule 2, Item 12, Section 14AA]

5.39 As an example, a statutory manager could facilitate a capital injection into an ADI by issuing new shares and selling them to a new investor. Under this example the new investor would gain a stake in the company and pre-existing shareholders would have their stake in the company diluted but would retain their shares in the ADI.

5.40 In conjunction with the above, it would also be possible to cancel existing shareholders' shares, which for example could be used to facilitate a new investor taking 100 per cent control of an ADI.

5.41 The recapitalisation powers are intended to be strong and flexible, in order to allow a statutory manager to respond quickly and decisively to a range of circumstances.

5.42 Prior to undertaking an action to recapitalise the ADI, the statutory manager is required to obtain an independent valuation report, which sets out the expert's opinion of the fair value of the shares and rights affected. The statutory manager is required to consider the report, and may find the contents useful when considering fair valuations, but is not compelled to follow the recommendations of the report when determining the terms of a recapitalisation action. [Schedule 2, Item 12, Section 14AB]

5.43 Existing section 69E of the Banking Act ensures that any action that would result in an acquisition of property from a person otherwise than on just terms would remain valid, with the Commonwealth liable to pay compensation of a reasonable amount as agreed with the person. Many potential recapitalisation actions however, are unlikely to result in an 'acquisition of property'. An example would be where existing shareholders' stakes in the company are diluted by the statutory manager issuing and selling new shares in the company.

5.44 The requirement applying to the expert valuation report, in relation to issuing, selling or cancelling shares, is similar to those of compulsory share acquisitions under the Corporations Act. Where the expert valuation report is required to give the fair value of rights attached to shares, the legislation does not prescribe how the valuation may be conducted, so as to provide flexibility to the expert valuer. This reflects the fact that there may be many types of rights attached to shares, and different valuation methods would be appropriate for different types of rights.

5.45 Whether the valuation report concerns issuing, selling or cancelling shares, or restricting or varying share rights, the Minister can give written notice to the expert valuer about valuation assumptions to be used in the report. The provisions specify that the instruments are not legislative instruments in order to assist readers, as the instrument is not a legislative instrument within the meaning of section 5 of the Legislative Instruments Act 2003 . [Schedule 2, Item 12, Subsections 14AB(4) and (6)]

5.46 The statutory manager is also required to comply with further procedural requirements, such as notifying all affected shareholders. [Schedule 2, Item 12, Subsection 14AA(2)]

5.47 The statutory manager may seek, from APRA, an exemption from the valuation report requirements. APRA may give this exemption if the APRA considers that taking the time needed to obtain and consider a valuation report would be detrimental to depositors' interests and the stability of the financial system. [Schedule 2, Item 12, Subsections 14AB(1) and (8)]

5.48 An exemption made by APRA from the valuation requirement is not a legislative instrument. This provision is included to assist readers, as the instrument is not a legislative instrument within the meaning of section 5 of the Legislative Instruments Act 2003 . [Schedule 2, Item 12, Subsection 14AB(8)]

5.49 In the interests of a timely recapitalisation, this power overrides any Corporations Act requirements, markets listing rules, any contractual arrangements and any provision in the entity's constitution. This means that members will not be able to seek members' remedies under the Corporations Act or seek a court injunction to delay the recapitalisation. Recapitalisation may also be effected even if the company constitution prohibits issuing a specified class of shares or prohibits a share issue unless certain 'entrenched' requirements are satisfied. [Schedule 2, Item 12, Subsection 14AA(4)]

5.50 A recapitalisation transaction cannot be used to trigger default or protective clauses under a contract with the financial institution, so that the contract or the other party to the contract cannot deny contractual obligations, accelerate debts or close out transactions merely because the statutory manager has implemented a recapitalisation (see also earlier section above, on no ending of contractual obligations). [Schedule 2, Item 12, Section 14AC] This change applies only to contracts made after commencement. The recapitalisation powers themselves apply to statutory managers appointed before, on or after commencement of the schedule. [Schedule 2, Item 13]

5.51 Acquisitions of shares in an ADI as a direct result of the use of the recapitalisation powers or acquisition of assets in a sale or disposal of the business in whole or in part by a statutory manager are authorised for the purposes of subsection 51(1) of the Trade Practices Act 1974 . [Schedule 2, Item 20, Section 16AA]

5.52 This exemption is intended to ensure that the transactions can occur quickly and give certainty to acquiring parties without formal competition review processes which may take some time. The Australian Competition and Consumer Commission (ACCC) can be consulted on the competition implications of such transaction under various other potential approval mechanisms, for example, the Treasurer's national interest decision under the Financial Sector (Shareholdings) Act 1998 .

5.53 The automatic authorisation applies to acquisitions occurring after commencement. [Schedule 2, Item 21]

Powers of ADI statutory managers to alter governance arrangements

5.54 An ADI statutory manager may alter the ADI's constitution, rules or other arrangements for governance where it may assist the statutory manager to perform its functions, duties and powers and it promotes the protection of the depositors of the ADI and financial system stability in Australia. [Schedule 2, Item 11]

5.55 This provides the statutory manager with plenary flexibility, as the clauses in the company's constitution or its governance arrangements may hinder a quick and decisive resolution of the failing ADI's affairs. An example of when governance arrangements could be altered is as part of, or following, a decision to recapitalise an institution.

5.56 As per statutory managers' powers for facilitating recapitalisation, the power to alter governance arrangements overrides any Corporations Act requirements, markets listing rules, any contractual arrangements and any provision in the entity's constitution. As above, the powers apply to statutory managers appointed before on or after commencement of the schedule.

Notice to APRA of external administration of ADI

5.57 A person who proposes to appoint an external administrator to a ADI must give prior notice to APRA. APRA can be heard at these applications. This requirement ensures that APRA has timely notice of these applications and can respond appropriately where necessary. For example, APRA may wish to oppose the appointment of an external administrator under Chapter 5 of the Corporations Act or may instead choose to appoint a statutory manager to the ADI. [Schedule 2, Item 22 Section 62B]

5.58 A person who applies for the appointment of an external administrator to an ADI without first notifying APRA commits a strict liability offence of up to 60 penalty units. [Schedule 2, Item 22 Section 62B]

5.59 This is a strict liability offence, as it may be difficult to show that the person's omission to notify APRA in this circumstance was intentional. This provision provides maximum incentive for such persons to ensure APRA is notified prior to an application for an external administrator to be appointed to an ADI.

5.60 The definition of external administrator is moved from subsection 15A(5) to subsection 5(1), in order to apply it to the entire Act. [Schedule 2, Items 1 and 16]

5.61 Where the liquidator of an ADI proposes to apply to Court in relation matters arising under the winding up of the ADI, it must give prior notice to APRA and APRA can be heard on the application. This provision is modelled on section 183 of the Life Insurance Act and ensures that APRA may make submissions on issues that affect the entity's depositors, or the stability of the financial system in Australia, where it is appropriate to do so. [Schedule 2, Item 22 Section 62C]

Minister's power to authorise contracts or arrangements to protect depositors or financial stability

5.62 Ministers have inherent powers to enter into contracts or arrangements on behalf of the Commonwealth. However, in order to be able to make payments in accordance with Commonwealth's obligations under such contracts or arrangements an appropriation authority is required prior to drawing money from Consolidated Revenue. A special appropriation mechanism is introduced into the Banking Act in order to allow such authority to be obtained in a timely manner if required.

5.63 The Minister may, with the written approval of the Finance Minister, authorise the making of contracts or arrangements for the main purposes of the Banking Act - that is, to protect the interests of depositors and financial system stability in Australia. [Schedule 2, Item 23, Section 70C]

5.64 This does not limit any other powers of the Minister to enter into contracts or arrangements.

5.65 The Minister must specify an amount in the authorisation to be credited to the Financial System Stability Special Account (the FSS Special Account).

5.66 The balance of the FSS Special Account attributable to such authorisations - total amounts credited under these authorisations but not yet expended for the purpose of meeting payments under authorised contracts or arrangements - must be less than $20,000,000,000 at any time. The amount specified can be amended but not revoked.

5.67 If the Minister has authorised a contract or arrangement, the Minister is also provided with a borrowing power, subject to the written approval of the Finance Minister. [Schedule 2, Item 23, Section 70D]

5.68 The Minister may borrow on behalf of the Commonwealth for up to 24 months for amounts totalling not more than $20,000,000,000 at any time. The borrowing power is intended as a contingency measure in order to ensure that the Commonwealth could obtain sufficient liquidity to meet obligations under contracts or arrangements if payments were required at very short notice. If cash was available at the time from Consolidated Revenue it is not envisioned that the use of the borrowing power would be required.

5.69 Similar provisions for authorising a contract or arrangement and associated borrowing are included in the Insurance Act [Schedule3, Item 26, Sections 131A and 131B] and Life Insurance Act. [Schedule 4, Item 34, Sections 251A and 251B]

5.70 The FSS Special Account is established in the Banking Act in order to provide an appropriation authority for payments under contracts and arrangements authorised under the Banking Act, Insurance Act and Life Insurance Act. [Schedule 2, Item 23, Sections 70E to 70H]

5.71 A special account is a ledger entry which records the right to draw money from the Consolidated Revenue Fund up to the balance of the account. The balance of a special account is increased by specifying amounts that are credited to the account, and such amounts can only be debited for the prescribed purposes of the account.

5.72 Amounts specified in authorisations in relation to contracts or arrangements authorised in the Banking Act, Insurance Act and Life Insurance Act provisions are credited to the FSS Special Account. Any amounts that are borrowed in connection with such authorisations are also credited to the FSS Special Account.

5.73 The balance of the FSS Special Account can only be spent on the purposes of the account. The main purpose of the account is making payments under contracts and arrangements authorised by the Minister. Repaying borrowings and meeting the expenses of administering the account are also prescribed as purposes of the account.

5.74 Finance Minister and Financial System Stability Special Account are defined in section 5(1). [Schedule 2, Items 2 and 3]