House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 5 Governance standards and external conduct standards

Outline of chapter

5.1 This Chapter sets up the framework for:

the minimum governance standards an entity must satisfy to be and remain a registered entity; and

the minimum external conduct standards an entity must satisfy to be and remain a registered entity.

5.2 The Governor-General may make regulations relating to the governance standards and external conduct standards.

5.3 The Governor-General is expected to make the standards principle-based, specifying the outcome to be achieved, rather than detailing how an entity must meet the standards in its particular situation.

5.4 The implications of the governance standards and external conduct standards will vary according to the circumstances of a particular registered entity. What a large entity must do to satisfy the requirements will be different from what a small entity must do to satisfy the same requirements.

Summary of new law

5.5 'Governance' is the set of practices and procedures in place to ensure that an entity operates to achieve its objectives in an effective and transparent manner.

5.6 Governance requirements may be included in:

existing governing rules, such as constitutions, association rules, cooperative rules, memorandum and articles of association, trust deeds, church laws and statutes;

contracts that governments enter into with some not-for-profit (NFP) entities; and

regulatory laws.

5.7 The current governance requirements of a NFP entity depend on:

the type of entity - such as whether it is unincorporated, a trust or a company limited by guarantee, subject to the legislation governing that entity type;

whether the entity is affiliated with a peak body - such as the Australian Council for International Development that has a code of conduct for its members; and

the sector in which the NFP operates - such as the health and education sectors, which have certain governance requirements that must be complied with for an entity to operate in that sector.

5.8 Some NFP entities are currently regulated by Commonwealth legislation, such as companies limited by guarantee, and some are regulated by the States and Territories, such as incorporated associations and charitable trusts. Most are regulated by a combination of Commonwealth and State laws.

5.9 In the absence of a registration regime, the role of de facto regulator for the NFP sector at the Commonwealth level has generally been shared between the ATO and ASIC, as discussed in Chapter 1 - Background.

5.10 The Bill sets up the framework for:

a set of governance standards which apply to most registered entities, and

a set of external conduct standards which apply to all registered entities, regardless of entity type,

and allows the Governor-General to make regulations relating to governance standards and external conduct standards.

5.11 These standards can cover such things as:

the content of a registered entity's governing rules;

the conduct of the registered entity; and

the processes that the registered entity must have in place.

5.12 There may be specific governance standards that apply differently to different groups of entities (such as those with members).

5.13 There may also be governance standards that do not apply to specified kinds of registered entity.

5.14 The governance standards will not apply to entities that are basic religious charities (see Chapter 13 - Miscellaneous for a definition of 'basic religious charity').

5.15 The external conduct standards will apply to all registered entities.

5.16 Only registered entities will have access to certain Commonwealth concessions, exemptions and benefits, including tax concessions.

5.17 To be registered, most entities will be required to meet (both initially, to the extent that they can, and on an ongoing basis) the governance standards established in the regulations.

5.18 To be registered, an entity is required to meet (both initially, to the extent that they can, and on an ongoing basis) the external conduct standards established in the regulations.

5.19 When an entity applies to the Australian Charities and Not-for-profits Commission (ACNC) to become a registered charity, they will initially be required to meet any governance standards which require entities to have certain things in their governing rules in order to be registered, and to show that they have required processes in place. Any governance standards which require certain conduct from registered entities may not be able to be demonstrated or met initially, but are to be met on an ongoing basis.

5.20 The governance and external conduct standards will set a minimum level of behaviour for all entities registered with the ACNC. As a result, the public can be confident that the funds the community gives to registered entities are being put to an appropriate use.

5.21 The standards will provide assurance that registered entities meet community expectations about the use of public monies, volunteer time and donations (such as using their resources efficiently), and minimise the risk of mismanagement and misappropriation.

5.22 Further, the standards will create a framework to protect entities and their mission or purpose from mismanagement, and will ensure that the entity is focussed on its mission, and not the goals or interests of others.

5.23 The standards are expected to be principle-based, specifying the outcome to be achieved, rather than detailing how an entity must meet the standards, in its particular situation.

5.24 A registered entity's prolonged non-compliance with a governance or external conduct standard could lead to the Australian Charities and Not-for-profits Commission Commissioner (ACNC Commissioner) revoking an entity's registration. See paragraphs 5.71 to 5.81.

5.25 For certain entities, the ACNC Commissioner may invoke the enforcement provisions in relation to non-compliance of the governance standards. For all entities, the ACNC Commissioner may invoke the enforcement provisions in relation to non-compliance of the external conduct standards (except to remove or suspend the responsible entity of a basic religious charity).

5.26 The ACNC Commissioner's education and guidance will assist registered entities to understand and comply with their obligations under the Bill. However, where enforcement action is required the ACNC Commissioner has a range of enforcement powers, including the power to issue directions, so that the ACNC Commissioner can provide a proportionate and effective regulatory response.

5.27 For example, the ACNC Commissioner may suspend a director if the ACNC Commissioner has reason to believe the entity has not complied with the governance standards or external conduct standards, and the removal of that director is necessary to address the breach. See Chapter 9 - Education, compliance and enforcement.

5.28 Transitional arrangements will be put in place in the regulations to allow registered entities time to make any necessary changes (for example, to internal procedures or their governing rules), to meet the governance standards and external conduct standards when they are established.

5.29 Registered entities must comply with the governance standards and external conduct standards as far as possible during the transition period without breaching their governing rules.

Detailed explanation of new law

Governance standards

5.30 The Bill sets up a framework for a set of principle-based minimum governance standards applying to most registered entities, regardless of entity type. Registered entities must comply with these standards in order to become registered (to the extent that they can, see paragraph 5.19), and to remain entitled to be registered. [Subsection 45-5(2)]

5.31 The Governor-General may make regulations establishing governance standards. [Subsection 45-10(1)]

5.32 These standards must by prospective see subsection 12(2) of the Legislative Instruments Act 2003 .

5.33 The standards can introduce principles that an entity must meet about such things as:

ensuring that its governing rules provide for a specified matter;

acting, or not acting, in a specified manner; or

establishing and maintaining processes for the purpose of ensuring certain matters,

in order to be and to remain entitled to be registered.

[Subsection 45-10(2)]

5.34 To be registered, most entities will be required to meet (both initially, to the extent that they can, and on an ongoing basis) the governance standards established in the regulations - see Chapter 3 - Registration.

5.35 There may be standards that do not apply to specified kinds of registered entity. [Subsection 45-10(3)]

5.36 The governance standards will not apply to entities that are basic religious charities (see Chapter 13 - Miscellaneous for a definition of 'basic religious charity'). [Subsection 45-10(5)]

5.37 In addition, there may also be specific governance standards that apply differently to different groups of entities (such as those with members or Indigenous charities). [Subsection 45-10(4)]

5.38 This could include the regulations requiring members of certain bodies to meet sector developed codes of conduct. In such a case, a prescribed sector developed code of conduct would be binding only on those members of an association or organisation that are signatories to the code, and a breach of the prescribed sector developed code of conduct would be a breach of the ACNC Bill. By allowing for the adoption of sector developed codes of conduct, the Government can utilise a co-regulatory model of governance where the sector is interested in developing such an approach.

5.39 Further, the ACNC Commissioner can endorse other codes of conduct, for entities who are members of certain bodies, as meeting the requirements of the governance standards.

5.40 The governance standards will ensure a minimum level of accountability across the sector.

5.41 If an entity is meeting the governance and external conduct requirements as established in the regulations, it does not mean that they are meeting best practice governance outcomes (although they may be).

5.42 The governance standards will give members, donors and volunteers of registered entities, and the rest of the public, confidence that a registered entity is operating openly, accountably and transparently, for its stated purpose, and in an effective and efficient manner, and is minimising the risk of mismanagement and misappropriation. [Subsection 45-5(1)]

Satisfying the standards

5.43 The standards are expected to be principle-based, specifying the outcome to be achieved, rather than detailing how an entity must meet the standards, in its particular situation.

5.44 The implications of the governance standards are expected to vary according to the circumstances of a particular registered entity.

5.45 Registered entities cannot choose whether to meet the standards in the regulations, but they can choose how they meet the standards, taking into account their specific situation.

5.46 In deciding what processes are reasonable for the entity to implement to satisfy the requirements, the registered entity would consider its size, the extent to which it receives donations, grants and other monies from governments or the public, the number of beneficiaries and the potential impact on them.

5.47 What a large entity must implement to satisfy the requirements will be different from what a small entity must do to satisfy the same requirements.

5.48 The larger an entity, and the more public monies it receives, the higher the community expectation that the entity is operating efficiently, effectively and consistently with its stated purposes, and therefore the more the entity can be expected to do to meet that expectation.

5.49 Smaller entities are not expected to be less transparent; however, their smaller nature usually means the risk of misuse of funds would be less than for a larger entity.

5.50 A smaller entity would usually have a smaller risk of funds being mismanaged or misappropriated, as both the value and the volume of transactions would usually be less, and the members would usually be running the entity. As such, the processes the entity would need to implement to safeguard against mismanagement and to operate openly and transparently would typically be less.

5.51 In addition, smaller entities will often have more limited resources to develop detailed and prescriptive governance policies.

5.52 The ACNC Commissioner will release guidance material to assist entities to determine how to comply with the governance standards.

External conduct standards

5.53 The Bill sets up a framework for a set of principle-based minimum external conduct standards applying to all registered entities, regardless of entity type, to regulate funds sent by registered entities outside Australia, and activities engaged in by these entities outside Australia. Registered entities must comply with these standards in order to become registered (to the extent that they can, see paragraph 5.19), and to remain entitled to be registered. [Subsection 50-5(2)]

5.54 The Governor-General may make regulations establishing external conduct standards. [Subsection 50-10(1)]

5.55 The standards can introduce principles that an entity must meet about such things as:

ensuring that its governing rules provide for a specified matter;

acting, or not acting, in a specified manner; or

establishing and maintaining processes for the purpose of ensuring certain matters,

in order to be and to remain entitled to be registered.

[Subsection 50-10(2)]

5.56 The external conduct standards can only relate to matters that are external to Australia, or to matters that are not external to Australia but that are closely related to, or have or will have a significant impact on, entities, things or matters outside Australia. [Subsection 50-10(3)]

5.57 Australian NFP entities in the past have sometimes provided support for terrorist and other criminal activities. Often they did so unknowingly but occasionally did so deliberately, whether to directly help the organisations conducting those illegal activities or as a means to achieving their legitimate charitable ends.

5.58 The purpose of these external conduct standards is to prevent Australian registered entities providing support in the future and so promote transparency and confidence across the sector and the general public that charitable funds and services are applied for legitimate purposes, and are not contributing to terrorist or other criminal activities (from an Australian perspective). [Subsection 50-5(1)]

5.59 The external conduct standards are expected to be based on the requirements of the Financial Action Task Force's (FATF) Special Recommendation VIII (SR VIII), and help combat the terrorist and criminal activities covered in the FATF recommendation

5.60 The FATF is an inter-governmental body established in 1989 to promote measures for combatting money laundering, terrorist financing and related threats to the integrity of the international financial system.

5.61 As a member of the FATF, Australia has agreed to comply with the FATF recommendations.

5.62 FATF SR VIII requires FATF members to 'combat the misuse of NPOs (nonprofit organisations, that is, NFP entities) for the purpose of terrorism financing'. In FATF's last review of Australia's progress in 2005, it found that Australia was only partially compliant with SR VIII.

5.63 Protecting the NFP sector from misuse by terrorist organisations is both a critical component of the global fight against terrorism and a necessary step to preserving the integrity of Australia's NFP sector.

5.64 The NFP sector enjoys the trust of the public and has access to a considerable source of funds. Some entities have a global presence that provides a framework for national and international operations and financial transactions, often within or near areas that are highly exposed to terrorist activity.

5.65 Depending on the legal form of the entity and the country they are operating in, entities may be subject to little or no governmental oversight of their overseas activities. There may also be few formalities required for their creation (for example, there may be no skills or starting capital required, and no background checks necessary for employees).

5.66 Terrorist organisations may take advantage of these characteristics to infiltrate the NFP sector and misuse funds and operations to provide cover for or support of terrorist activities. Other criminal organisations can also use NFP entities for similar purposes. The FATF recommendation covers both these situations.

5.67 The external conduct standards will promote transparency and greater confidence in the sector, across the donor community, and with the general public that charitable funds sent, and services provided, overseas are reaching legitimate beneficiaries and being used for legitimate purposes.

5.68 Systems that promote a high degree of transparency, integrity and public confidence in the management and functioning of all NFP entities are integral to ensuring the sector cannot be misused for terrorist financing.

5.69 Similar to the governance standards, the external conduct standards are expected to be principle-based, specifying the outcome to be achieved, rather than detailing how an entity must meet the standards, in its particular situation. What a large entity must implement to satisfy the requirements will be different from what a small entity must do to satisfy the same requirements.

5.70 In deciding what processes are reasonable, the registered entity should consider not only its size (see paragraphs 5.46 and 5.51), but also the extent to which it receives donations, grants and other monies from the public (directly or via their governments), the number of beneficiaries and the potential impact on them.

Non-compliance with the governance standards and external conduct standards

Governance standards

5.71 Compliance with the governance standards is a condition of registration.

5.72 Prolonged non-compliance with a governance standard may result in the ACNC Commissioner revoking the registration of the entity - see Chapter 3 - Registration.

5.73 The ACNC Commissioner's education and guidance will assist registered entities to understand and comply with their obligations under this Bill. Prior to revoking an entity's registration, the ACNC Commissioner would be expected to assist the entity in complying with the standard. Revocation of registration is expected to be a last resort outcome.

5.74 However, where enforcement action is required the ACNC Commissioner has a range of enforcement powers, including the power to issue directions, so that the ACNC Commissioner can provide a proportionate and effective regulatory response. The type of enforcement power used by the ACNC Commissioner will ultimately depend on the seriousness of the situation and the particular circumstance that the ACNC Commissioner is addressing.

5.75 If a non-complying entity is a federally regulated entity (see Chapter 9 - Education, compliance and enforcement for the definition of 'federally regulated entity'), the ACNC Commissioner may issue a warning notice or direction to the entity if the ACNC Commissioner considers that the entity is not meeting the governance standards.

5.76 For example, the ACNC Commissioner may suspend a director if the ACNC Commissioner has reason to believe the entity has not complied with the governance standards, and the removal of that director is necessary to address the breach.

5.77 The ACNC Commissioner cannot remove or suspend a responsible entity of a basic religious charity.

5.78 See Chapter 9 - Education, compliance and enforcement for further information on the situations that the ACNC Commissioner can use these powers, and the extent of the powers.

External conduct standards

5.79 Compliance with the external conduct standards is a condition of registration for all registered entities.

5.80 The ACNC Commissioner may use enforcement powers (such as issuing a warning notice, injunction or suspending a director) on any entity if the ACNC Commissioner considers that that an entity is not meeting the external governance standards (except to remove or suspend the responsible entity of a basic religious charity). This is different to the governance standards, where the ACNC Commissioner may only use the enforcement powers if the non-complying entity is a federally regulated entity.

5.81 See Chapter 9 - Education, compliance and enforcement for further information on the situations that the ACNC Commissioner can use these powers, and the extent of the powers.