House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Minister for Financial Services, Superannuation and Corporate Law, the Hon Chris Bowen MP)

Chapter 2 - ASIC supervision and market integrity rules

Outline of chapter

2.1 The Corporations Amendment (Financial Market Supervision) Bill 2010 (the Bill) inserts a new Part 7.2A into the Corporations Act 2001 (the Act) relating to Australia Securities and Investments Commission's (ASIC's) new function of supervisor of domestic licensed financial markets in Australia.

Context of amendments

2.2 At present Australian market licensees are primarily responsible for setting rules in relation to behaviour on Australia's financial markets. This is done through the market's operating rules.

2.3 As part of the decision to transfer supervisory responsibility to ASIC, ASIC will be given the ability to set rules in relation to Australia's financial markets and additional powers to enforce these rules.

2.4 These amendments were part of an exposure draft and consultation paper which was released for public consultation on 2 December 2009.

Summary of new law

2.5 The amendments confer on ASIC the function of supervising Australia's domestic licensed financial markets.

2.6 The amendments establish a regime whereby ASIC can set rules in relation to domestic licensed financial markets, and provide ASIC with additional methods for enforcing compliance with the rules.

2.7 The Bill makes consequential amendments to other provisions in the Act to reflect the establishment of a new rule making regime, and to extend other provisions to include these rules.

Comparison of key features of new law and current law

Detailed explanation of new law

2.8 The Bill contains a variety of amendments to provide ASIC with the tools necessary to perform supervisory functions in relation to domestic licensed financial markets.

ASIC and financial market supervision

2.9 The Bill confers on ASIC the function of supervising domestic licensed financial markets. This function involves ASIC utilising systems to monitor the trading of financial products on domestic licensed financial markets. Having this function will allow ASIC to more easily detect and enforce the market misconduct provisions in the Act as well as enforce the new rules which it will make. [Schedule 1, item 14, section 798F]

2.10 A decision was made not to require ASIC to directly supervise overseas financial markets which are licensed to operate in Australia as the Act allows such markets to operate in Australia on the basis of sufficiently equivalent regulation.

Market integrity rules

2.11 The Bill provides for ASIC to make market integrity rules. These market integrity rules can deal with the activities and conduct of licensed markets, and of persons in relation to licensed markets and financial products traded on licensed markets. [Schedule 1, item 14, subsection 798G(1)]

2.12 ASIC intends to consult with stakeholders regarding the introduction of the proposed market integrity rules. In cases where it is not possible to consult prior to the introduction of a market integrity rule, ASIC intends to subsequently review implementation arrangements relating to the rule.

2.13 These rules do not apply in relation to overseas markets with an Australian market licence. This is because operators of such markets are expected to be subject to the changes by implication. The Act provides that an operator of an overseas market can only be granted a licence where the Minister is satisfied that the regulatory regime the market is subject to is sufficiently equivalent to Australia's. In the future this would include taking into consideration the new regulatory framework applying to domestic Australian market licence holders. [Schedule 1, item 14, subsection 798H(2)]

2.14 The Bill allows ASIC to make market integrity rules in a wide range of areas. The current law already allows markets to make operating rules, which also cover a wide range of areas. Operating rules and market integrity rules will operate together, but to the extent of any inconsistency the market integrity rule will prevail and the operating rule will have no effect. The regime is designed to be flexible and to allow ASIC to make rules to cover new and emerging issues as the market adapts and innovates, while also recognising that every market is different and needs operating rules tailored to the specifics of that market. [Schedule 1, items 11 and 14, subsection 798G(1)]

2.15 A breach of a market integrity rule will be a breach of a civil penalty provision of the Act, and subject to a pecuniary penalty of up to $1 million. ASIC will set a penalty amount for the breach of a market integrity rule where it is appropriate to do so. This reflects the broad range of matters which the market integrity rules are expected to cover. Some rules will relate to minor and technical or procedural matters and it will be appropriate that a lower penalty level, or no penalty, attach to those rules. [Schedule 1, items 14, 25 to 27, subsections 798G(2) and 798H(1)]

2.16 Before ASIC can make a market integrity rule, ASIC must have the written consent of the Minister. The Bill does provide for ASIC to be able to make a market integrity rule without the prior approval of the Minister in emergency situations. If ASIC does so, on the following day it must justify to the Minister in writing the need for the rule, and revoke or amend the rule in accordance with any written direction of the Minister. These provisions are included to ensure that ASIC has the capacity to respond instantly to serious emerging market situations, while also ensuring that the role of the Minister is maintained. It is expected that ASIC will make rules without seeking the Minister's prior consent only in limited situations where ASIC needs to respond swiftly to a situation and there is insufficient time to get the prior written approval of the Minister. [Schedule 1, item 14, subsections 798G(3) to (5)]

2.17 The Bill states that the consent provided by the Minister for the making of a market integrity rule, and a direction by the Minister to ASIC to vary or revoke a rule, are not legislative instruments. This provision clarifies that these instruments are not legislative instruments as such documents are only interim steps in the rule making process. The market integrity rule, when made, will be a legislative instrument and subject to parliamentary scrutiny. [Schedule 1, item 14, subsection 798G(6)]

2.18 Market integrity rules will be enforceable against operators of, and participants in, licensed markets. The Bill also provides a regulation making power allowing for the regulations to specify other entities that the rules may be enforced against. This regulation making power is needed to allow the framework to develop to meet innovations and new players in the market. The financial market is by nature fluid and often involves complex and changing financial arrangements. It may be necessary to apply these rules to additional entities. If it becomes clear that this is necessary, the rules may need to be applied swiftly to ensure the integrity of the market is maintained. The regulation making power will allow the framework to adapt quickly to developments in the market. [Schedule 1, item 14, section 798H]

Enforcement of the market integrity rules

2.19 The Bill provides that a breach of a market integrity rule will be a breach of a civil penalty provision [Schedule 1, item 27] . This enables a Court to order a person to pay a pecuniary penalty to the Commonwealth if a declaration of contravention has been made. However the maximum that a Court can order a person to pay for contravention of the rule will be the amount set by ASIC in the market integrity rule. The maximum penalty amount that ASIC can set for breach of a market integrity rule is $1 million. This reflects that the market integrity rules will cover a variety of areas, and the penalties will range in severity in line with the nature of the rule. [Schedule 1, item 28]

2.20 The Bill also provides for compensation orders to be made by a Court where damage has resulted from the contravention of a market integrity rule. The Bill does not provide for compensation orders to be made against market operators. This is because market operators are at the centre of the financial system, and therefore are potentially open to claims from all participants in financial markets for a breach of a market integrity rule. There would be systemic risks in opening markets up to claims for compensation of an indeterminate liability. For this reason market operators have been excluded from the compensation provision. [Schedule 1, item 29]

2.21 The Bill also establishes a framework, to be developed in regulations, for there to be alternatives to civil proceedings. It is important that ASIC has a wide range of options at its disposal for enforcing the market integrity rules. Currently markets have the ability to deal with breaches of their operating rule expeditiously and efficiently, with penalties ranging from fines, suspension of participation and enforcing the establishment of education and compliance programs. The Bill allows ASIC to deal with breaches of the market integrity rules expeditiously by providing for a person to make a payment and/or undertaking to do something, such as instituting remedial measures or entering into an enforceable undertaking as an alternative to civil proceedings. If a person decides to enter into an alternative to civil proceedings the monetary amount payable cannot exceed three-fifths of the maximum that a court could require payment of. [Schedule 1, item 14, section 798K]

2.22 The details of the alternatives to proceedings will be established in the regulations. The regulations will establish an infringement notice and enforceable undertaking framework under this provision.

2.23 The alternatives to civil proceedings work on the basis that persons who are alleged to have contravened a market integrity rule, which in turn will be a breach of a civil penalty provision, can opt to enter into an infringement notice or enforceable undertaking with ASIC, as an alternative to ASIC pursuing the matter in Court. Such remedies are vital to the ongoing success of the market integrity rule framework as they provide ASIC with a fast and effective remedy, akin to the remedies available to markets under the current operating rule framework.

2.24 The regulations will also set out things such as the detailed requirements for the issue and service of a notice, matters to be included in the notice or undertaking, effect of the issue and compliance with a notice or undertaking, the effect of failure to comply with a notice or undertaking, the compliance period for a notice or undertaking, the withdrawal of a notice or undertaking, and the publication of the notice or undertaking. It is appropriate that such details are set out in the regulations as they are technical and procedural in nature.

2.25 The Bill provides ASIC with a power to issue directions in relation to entities dealing in financial products, or a class of financial products, or in relation to such dealings. This directions power is necessary so ASIC can intervene to halt dealings in a financial product in order to protect people and thereby ensure the integrity of the market. For example, ASIC could direct a broker to stop trading in a product where the dealings would lead to contravention of the Act or a market integrity rule, or would impact on the integrity of the market. Such directions will be enforceable by the Court. [Schedule 1, item 14, section 798J]

Application and transitional provisions

2.26 All provisions in the Bill, will take effect on a date fixed by Proclamation. If commencement does not take place within 12 months of the day the Act receives Royal Assent, then the provisions are repealed. Commencement of the Fees Bill takes place on the date the main Bill commences. [Schedule 1, item 34, section 1512]

2.27 The Bill provides for regulations to be able to make exemptions from and modify the legislation. Provisions which allow similar exemption and modification are spread throughout the Act. Including such a provision in this new Part is in line with the construction of the Act and similar provisions applying in respect of existing Parts. This regulation making power is needed to allow the framework to develop to meet innovations in the market. The financial market is by nature fluid and it may be necessary to apply the rules differently to different entities. If it becomes clear that this is necessary, the rules may need to be modified swiftly to ensure the integrity of the market is maintained. The regulation making power will allow the framework to adapt quickly to developments in the market. [Schedule 1, item 14, section 798L]

2.28 In addition, the Bill allows regulations to provide for transitional arrangements. This will allow arrangements of a transitional nature to be implemented if it is determined that they are required. This will be important if practical issues arise over the coming months with the transfer of responsibility for supervision from market operators to ASIC. [Schedule 1, item 34, section 1513]

Consequential amendments

2.29 The Bill proposes a number of consequential amendments to other provisions in the Act to reflect the new functions of ASIC.

2.30 The Bill updates provisions to refer to the new form of civil penalty and new directions power. [Schedule 1, items 1 to 4 and 15]

2.31 The Bill extends the application of qualified privilege provisions to the giving of information to ASIC in relation to a contravention or suspected contravention of a market integrity rule. This is important to ensure concerns about breaching confidentiality do not prevent ASIC from being able to perform its functions. [Schedule 1, item 16]

2.32 The Bill amends the court order provisions of the Act to apply to contraventions of market integrity rules. This ensures that a Court has wide powers to issue orders which the Court deems necessary when hearing a case concerning the contravention of a market integrity rule. [Schedule 1, items 19 to 23 and 30 to 33]

2.33 The Bill also excludes certain decisions from review of the Administrative Appeals Tribunal (AAT). This is done to remove any doubt and to confirm that such decisions are not subject to AAT review. It is appropriate that such decisions are not subject to review by the AAT, as the decisions excluded are more akin to policy and rule-making decisions and should not be subject to merit review. [Schedule 1, item 24]

Supporting amendments

2.34 The Bill confers new functions and responsibilities on ASIC. The Wallis Inquiry, which reported in 1997, made a recommendation that regulatory agencies should collect enough revenue from the financial entities which they regulate to fund themselves. The principle is that for reasons of equity and efficiency, the costs of financial regulation should be borne by those who benefit from it.

2.35 In line with this principle, the Fees Bill provides ASIC with the ability to impose a fee on market operators in relation to the functions it will be performing under the Bill. The Regulations will specify how the fee will be calculated and when it will be imposed. [Schedule 1, items 1 and 5 of the Corporations (Fees) Amendment Bill 2010]

2.36 The Bill places no cap on the amount that ASIC can charge in relation to the performance of its supervisory functions [Schedule 1, item 3 of the Corporations (Fees) Amendment Bill 2010] . This is because the amount it will cost to supervise the market, and therefore also the amount it will be necessary for ASIC to recover, will change dramatically as financial markets enter and leave Australia, and as the amount of trades executed on markets in Australia fluctuate in response to market conditions. The formula for calculation of the levy on market operators will be set out in the Regulations and will be consulted upon with industry before being introduced. [Schedule 1, item 4 of the Corporations (Fees) Amendment Bill 2010]

2.37 The commencement of the Fees Bill is linked to the commencement of the main Bill as the two bills are connected. The Fees Bill will come into effect on the same date that the Bill does. Do not remove section break.