House of Representatives

Explanatory Memorandum

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

Glossary

The following abbreviations and acronyms are used in this explanatory memorandum.

General outline and financial impact

General background

The Council of Australian Governments (COAG) reached an in-principle agreement on 26 March 2008 that the Australian Government would assume responsibility for regulating mortgage credit and advice, margin loans and trustee companies.

In June 2008, the Australian Government issued the Green Paper Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Reform. The paper sought feedback on possible reforms to the regulation of a number of areas in the financial services sector through the Corporations Act 2001 (Corporations Act). These areas included margin loans, trustee companies and debentures.

Following on from that process, the Australian Government issued an exposure draft of a Bill setting out a number of proposed amendments relating to margin lending, trustee companies and debentures regulation. A substantial number of submissions were received and appropriate changes were made to the draft legislation following consideration of the issues raised.

The Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 (Bill) contains proposed measures on:

•

Margin lending: Margin loans are to be included as financial products for the purposes of Chapter 7 in the Corporations Act. Margin loans to date have been inconsistently regulated. Inclusion in the Corporations Act will establish an investor protection regime by ensuring that providers of financial services in relation to margin loans will be subject to the licensing, conduct and disclosure requirements in Chapter 7 as well as supervision and enforcement action by the Australian Securities and Investments Commission (ASIC). In addition two key new measures are being introduced to address specific investor protection issues arising for margin loans:

-

a new responsible lending requirement, prescribing that margin loan lenders must make an assessment of whether a proposed loan will be unsuitable for a client, and to not make the loan if it is found to be unsuitable; and

-

a provision regulating the notification of margin calls to clients, especially where the loan has been arranged through a financial planner.

•

Trustee companies: A new chapter (5D) is to be inserted into the Corporations Act to transfer regulation of trustee companies from the States and Territories to the Commonwealth. These changes will harmonise the regulation of trustee companies, thereby reducing the regulatory burden on these companies while creating a national market for trustee services. The new chapter will also protect consumers by establishing a national consumer protection and disclosure regime under the Corporations Act and the Australian Securities and Investments Commission Act 2001 (ASIC Act). The new legislation will:

-

authorise certain corporations to operate as trustee companies and require them to hold an Australian financial services licence (AFSL);

-

deem 'traditional trustee company services' to be 'financial services' for the purposes of the Corporations Act;

-

provide that ASIC will regulate trustee companies in the provision of these traditional services;

-

apply the consumer protection (licensing, conduct, disclosure, advice and dispute resolution) provisions of the Corporations Act and the ASIC Act, as modified;

-

regulate the fees that trustee companies may charge, and how those fees are disclosed; and

-

prohibit a company that is not a trustee company from providing traditional trustee company services.

•

Debentures regulation: Amendments are proposed relating to the harmonisation of the regulation of debentures and promissory notes, and the creation of a debentures trustee register. The two proposed changes are as follows:

-

a promissory note with a face value of at least $50,000 will now be included under the definition of a debenture. This measure should assist in ensuring that there are no further attempts to avoid the operation of the law in relation to the issue of promissory notes; and

-

the creation of a publicly available register of trustees for debenture holders.

•

Technical amendment: It is proposed to correct an omission in subsection 1338B(8) of the Corporations Act relating to the jurisdiction of State and Territory courts with respect to certain offences.

Dates of effect:

Margin loans - The amendments take effect on a day to be fixed by Proclamation or the expiry of the period of six months beginning on the day on which the Bill receives Royal Assent, whichever is the earlier.

Trustee companies - The amendments take effect on a day to be fixed by Proclamation or the expiry of the period of six months beginning on the day on which the Bill receives Royal Assent, whichever is the earlier.

Debentures - The amendment relating to the harmonisation of the regulation of promissory notes takes effect on the day Royal Assent is received. The amendments relating to the establishment of the register of debenture trustees take effect on a day to be fixed by Proclamation or the expiry of the period of six months beginning on the day on which the Bill receives Royal Assent, whichever is the earlier.

Technical amendment - The amendment takes effect on the day Royal Assent is received.

Financial impacts:

Margin loans - The Government has provided $70.2 million over four years to implement the decision of the COAG to transfer responsibility for regulating consumer credit to the Commonwealth as part of the 2008-09 Mid-year Economic and Fiscal Outlook (MYEFO). This Bill includes measures to give effect to part of that transfer relating to the regulation of margin loans.

The funding will support the establishment of a national licensing regime applying to all credit providers, advisers and brokers with ASIC as the sole regulator. It will also support the national regulation of mortgages, margin lending, personal and business loans, credit cards and payday lending. The funding will be partially offset by revenue raised from fees required to be paid by persons under the national regulatory framework, including licensing fees, commencing from 2009-10. The revenue generated from licensing fees will depend on the number and type of the persons seeking registration.

Trustee companies - The financial impact is expected to be absorbed in ASIC's current budget.

Debentures - Has no significant impact on Commonwealth expenditure or revenue.

Technical amendment - Nil.

Compliance cost impacts:

Margin loans - Low to medium - these measures will create additional compliance costs for margin loan lenders and advisers, as they will be required to obtain a licence from ASIC and comply with a range of conduct and disclosure requirements.

Trustee companies - Low to medium - while there will be compliance costs associated with a client protection regime, for example, requirements for reporting and dispute resolution, these would be relatively minimal.

Debentures - These measures affect only a small number of businesses and have a low cost impact.

Technical amendment - Nil.

Summary of regulation impact statement

Regulation impact on business

Margin loans:

Impact: This measure affects financial services providers offering and advising on margin loans as their services become subject to a comprehensive range of licensing, conduct and disclosure requirements.

Main points:

•

Persons providing and advising on margin loans will be required to obtain an AFSL. They will be subject to supervision and enforcement by ASIC.

•

Such persons will become subject to the requirements imposed on AFSL holders in Chapter 7 of the Corporations Act. These requirements include, among other things, obligations to put appropriate compensation and dispute resolution arrangements in place, provide prescribed disclosure documents to their clients and observe a range of conduct requirements.

•

Consumers are the main beneficiaries of the amendments introduced in the Bill. They will benefit from the requirements for AFSL holders to be properly trained and resourced, access to free dispute resolution services, targeted and regulated disclosure documents, the responsible lending provisions and other protections in the new margin loan regulatory regime.

Trustee companies:

Impact: This measure affects companies offering traditional trustee company services, as they will be subject to a range of licensing, conduct and disclosure requirements (however, such companies already hold AFSLs covering other services). They will also be subject to internal and external dispute resolution mechanisms and compensation arrangements.

Main points:

•

Trustee companies will benefit from a single licensing regime with transparency and objective criteria. Directors will be relieved of personal liability obligations, except in the limited circumstances prescribed by the Corporations Act.

•

Trustee companies will be subject to a 15 per cent limit on individual voting power and, in cases of loss of licence, may be subject to compulsory transfer of their assets and liabilities.

•

Consumers will benefit from greater fee disclosure, a uniform fee regulation regime and low cost dispute resolution.

Debentures:

Impact: The impact of the harmonisation measure is expected to be low as the number of businesses affected by the change is understood to be relatively small.

Main points:

•

It is expected that only a small number of businesses will be affected by the change.

•

The major cost will be for trustee arrangements to be established for issues falling within the new definition, but these costs are not expected to be high.

•

Only one party responded in the consultation period, and that party supported the change.

Technical amendment

Impact: None.

Chapter 1 - Margin loans

Outline of chapter

1.1 Schedule 1 to the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 (Bill) amends the Corporations Act 2001 (Corporations Act) to set out a national regulatory regime for margin loans. Such loans are not directly regulated and are not subject to the state based consumer credit law.

1.2 The national regulatory regime for margin loans is established by including margin loans as a financial product in Chapter 7 of the Corporations Act. Chapter 7 regulates the provision of financial services supplied in relation to financial products (which are primarily of an investment nature). As margin loans are a form of credit widely used to finance acquisitions of investment-related financial products, Chapter 7 is considered to provide the appropriate regulatory setting for the regulation of margin loans.

1.3 Chapter 7 does not fully cover all aspects of margin loans as the regulatory regime was not originally designed for credit products. Accordingly, a number of adjustments are necessary to ensure the regime fits the characteristics of margin loans and that an appropriate level of investor protection is provided.

Context of amendments

1.4 A margin lending facility allows an investor to borrow money to invest in securities and other financial products against the security of any equity contribution, usually in the form of financial products.

1.5 Depending on the margin lending product and the provider, securities and other financial products may include listed shares, fixed interest securities and units in managed funds. In practice, margin loans are usually only available to fund purchases of 'approved' securities that the lender regards as acceptable from a risk and liquidity perspective. However, funds raised by way of a margin loan could potentially be used to purchase other financial products, goods or services.

1.6 Margin loan facilities are based on contractual arrangements between the lender and the client. Primary disclosure of the terms and conditions governing the loan occurs through the lending agreement signed between the two parties. As this disclosure is not currently regulated, it is not clear that investors are fully aware of the risks associated with a margin lending product.

1.7 The amount an investor can borrow generally depends on the loan-to-value ratio (LVR) offered by a lender for the securities or other financial products. The lender may reserve the power to change the assessed market value and LVR of a security at any time.

1.8 The money that the investor borrows in a margin loan is generally secured by these underlying investments. The investor retains legal rights over the investments.

1.9 However, an investor can also provide other assets, such as their home or investment properties, as security for the loan.

1.10 Repayment of a margin loan may be required in the event the investment is subject to a 'margin call'. A margin call occurs where the market value of the investments falls below the level agreed under the contract (margin). The borrower is then required to take action in order to return the margin loan LVR back to the agreed level. Lenders usually provide a 'buffer' above the LVR rate before initiating a margin call, which may or may not form part of the terms of the margin loan agreement.

1.11 When there is a margin call, the investor is required to adjust the level of assets securing the loan to return the portfolio to the agreed limits set under the contract. This can be done by paying extra cash, selling some of the assets, or giving the lender additional security.

1.12 A lender has recourse to the underlying security if there is a default on the terms or conditions of the loan and retains the right to take action against the borrower personally for such defaults.

1.13 Margin lending has grown strongly in recent years, with recent marketing of margin lending extending from high net worth individuals who generally are experienced investors, to a wider circle of retail investors. However, due to current market conditions, levels of lending have started to fall.

1.14 Margin loans are closely related to other financial products, such as shares or managed investments, which are already regulated under Chapter 7.

Current legislative framework

1.15 Currently, margin lending facilities are not regulated as a financial product, or subject to Australian Securities and Investments Commission (ASIC) regulation relating to financial services. This is because the term 'financial product' in the relevant legislation does not cover credit products (such as margin loans) as a result of the current referral agreement with the States and Territories. Further, State and Territory legislation governing consumer credit (the Uniform Consumer Credit Code) excludes investment loans such as margin lending.

1.16 However, there are regulatory measures which capture aspects of the margin lending product. This includes:

•

The Australian Securities and Investments Commission Act 2001 (ASIC Act) gives ASIC the function of monitoring and promoting market integrity and consumer protection in relation to financial services. For the purpose of the ASIC Act, credit facilities (which include margin loans) are financial products and are subject to general consumer protection provisions of the Act, such as those relating to misleading and deceptive conduct.

•

As margin loans are supplied by a variety of providers, including banks and stockbrokers, various industry regulations may apply, including, for example, the Code of Banking Practice and the ASX Market Rules.

Key risks

1.17 There have been serious concerns that not all margin borrowers are aware of the extent to which margin lending contracts place the risk of changes to market conditions on them. The possibility of such borrowers suffering unexpected consequences is particularly high in volatile market conditions such as those experienced since the impact of the global recession.

Opes Prime style arrangements

1.18 Following the collapse of Opes Prime and serious problems at Tricom, it was found that these entities were using arrangements that were promoted as 'margin loans' to the consumer, and functionally operated as such. However, they were based on different legal arrangements that did not necessarily involve a 'loan' and were more closely related to stock or 'securities' lending. Therefore, concerns have been raised that consumers were misled as to the implications of these facilities.

Double gearing

1.19 There have been recent cases where clients who had entered into margin loan arrangements are at risk of losing their homes due to double gearing strategies. Double gearing arises where clients borrow funds against the equity in their homes and use them as their equity contribution to a margin loan.

1.20 Through an unfortunate combination of circumstances some of these borrowers have fallen into negative equity in relation to the value of their security vis-à-vis their margin loan and are now having to repay outstanding amounts on the margin loan as well as continuing to service the loan secured against their home. Where borrowers do not have additional sources of funds to do so, they are at risk of losing their homes.

1.21 Indications are that not all of these borrowers were familiar with the way in which a margin loan operates, including the potential consequences of margin calls. In addition, they may also not have been fully aware that they exposed themselves to the risk of losing their homes when they borrowed against their home to fund the margin loan.

Margin calls

1.22 Recent events have also raised concerns about whether the adviser or lender is responsible for notifying a client of a margin call.

1.23 Failure to notify a client of a margin call in a timely manner can result in significant losses, including resulting in a client going into negative equity.

Summary of new law

1.24 Margin loans are given a specific definition in the Corporations Act to ensure that all arrangements with the relevant characteristics of a margin loan are captured under the new national regime. Complications arise in this area because alternative legal structures not based on an explicit loan agreement have been used by providers such as Opes Prime and Tricom. The definition has been framed in a manner to include these alternative 'margin loan' type structures.

1.25 A 'margin lending facility' is explicitly included as a financial product for the purposes of Chapter 7 in the Corporations Act. This ensures that providers of financial services in relation to margin loans will be subject to the licensing, conduct and disclosure requirements in Chapter 7. It also subjects them to supervision and enforcement action by the national regulator, ASIC.

1.26 It is noted that the definition of margin loans as a financial product only extends to loans provided to individuals, as it is not intended at this stage to regulate business lending. Australian Government policy in relation to business lending will be developed in phase two of the Commonwealth's assumption of responsibility for the regulation of credit.

1.27 The investor protection regime under Chapter 7 of the Corporations Act requires that persons providing financial services and products must, among other things:

•

have an Australian financial services licence (AFSL);

•

comply with general conduct standards, including the requirement to deal with investors efficiently, honestly and fairly;

•

have appropriate compensation arrangements in place for losses suffered by retail clients due to breaches of the law. This includes membership of an ASIC approved External Dispute Resolution Scheme (EDR Scheme);

•

provide appropriate disclosure to their retail clients before and after a product is purchased, including providing a product disclosure statement, a statement of advice and periodic statements on an ongoing basis;

•

have in place adequate arrangements for the management of conflicts;

•

ensure that they have adequate resources and are competent to provide the services. They must also ensure that their representatives are adequately trained and competent to provide the services; and

•

be subject to the enforcement provisions surrounding market manipulation, false or misleading statements, inducing investors to deal using misleading information, and engagement in dishonest, misleading or deceptive conduct.

1.28 The inclusion of margin loans within Chapter 7 will require margin lenders and advisers to obtain an AFSL and imposes this range of conduct and disclosure requirements on them.

1.29 With respect to licensing, the main financial services that are anticipated to be covered will be issuing (largely equivalent to lending) and the provision of advice in relation to margin loans. Appropriate transitional arrangements are provided to ensure that the licensing process occurs smoothly. This is particularly important for financial advisers, as the numbers involved are large and will require some time for ASIC to process.

1.30 A new responsible lending requirement that applies specifically to margin loan lenders is imposed seeking to ensure that clients are not given loans which they are unable to service. Lenders will be required to assess whether a proposed loan is unsuitable for the client, such that in the event of a margin call the client would not be able to service the loan or would only be able to do so with substantial hardship. If a loan is assessed as unsuitable, it must not be provided to the client.

1.31 A number of key factors that need to be considered by lenders in assessing unsuitability will be prescribed in regulations, including in particular situations where consumers have engaged in 'double gearing'. This term refers to situations where consumers borrow funds to finance their equity contribution for a margin loan. In some cases borrowers may use their residential home as security for the loan, which is considered to be a major risk factor as consumers may lose their homes if they are unable to service the loans.

1.32 A further provision regulates the notification of margin calls to clients, especially where the loan has been arranged through a financial planner. There have been situations where it has been unclear whether it was the lender or the planner who was responsible for notifying clients when a margin call occurred. Failure to notify a client in time can result in losses for the client. The amendments require that lenders must notify clients when a margin call is made, unless clients explicitly agree to notifications being provided through their planner.

Comparison of key features of new law and current law

Detailed explanation of new law

Definition of a margin lending facility

Capture as a financial product

1.33 An appropriate amendment is made to the table containing an outline of Chapter 7 to reflect the new amendments relating to margin loans. [Schedule 1, item 1]

1.34 A number of key terms used in the amendments are inserted into section 761A, which contains a number of key definitions for Chapter 7 of the Corporations Act. [Schedule 1, items 2 to 7]

1.35 A margin lending facility is included in the list of specific facilities that are financial products in paragraph 764A(1)(k) of the Corporations Act [Schedule 1, item 10]. This will trigger a range of obligations that apply to a financial product in Chapter 7 of the Corporations Act.

1.36 A margin lending facility is specifically excluded from subparagraph 765A(1)(h)(i) of the Corporations Act, which exempts credit facilities from the meaning of financial product [Schedule 1, item 11]. This is to make clear that a margin loan facility does not fall in the general exclusion of credit matters in the Corporations Act.

Meaning of issue of margin lending facility

1.37 The issue of a margin loan is a key concept in determining whether a person needs to obtain an AFSL. An amendment to subsection 761E(3) (at the end of the table) clarifies when a margin loan has been issued to a client. A margin lending facility is issued to a person when they enter into the legal relationship that constitutes the margin lending facility, as the client under the facility. [Schedule 1, item 8]

General definition - margin lending facility

1.38 A specific definition of a margin lending facility is considered appropriate to ensure that other lending practices are not inadvertently captured in the definition.

1.39 Section 761EA gives meaning to a range of definitions associated with a margin lending facility. [Schedule 1, item 9]

1.40 A margin lending facility is [Schedule 1, item 9, subsection 761EA(1)]:

•

a standard margin lending facility;

•

a non-standard margin lending facility; or

•

a facility declared by ASIC to be a margin lending facility (unless the facility has been declared by ASIC not to be a margin lending facility).

1.41 The definition is intended to capture, among other things:

•

the basic or 'vanilla' margin loan;

•

Opes Prime and Tricom style arrangements, where appropriate. This is to ensure that products that are functionally similar to a margin loan (and advertised as a margin loan) are also captured;

•

hybrid products that utilise the key features of a margin loan;

•

a limited or non-recourse margin loan (where the amount the lender can recover is restricted to the mortgaged financial product); or

•

a margin loan where the assets securing the loan are more than just the financial products purchased through the loan, such as residential property.

1.42 Other forms of investment lending more generally will be addressed separately in the Commonwealth's broader reforms to consumer credit.

Standard margin lending facilities

1.43 A definition of a 'standard margin lending facility' is provided [Schedule 1, item 9, subsection 761EA(2)]. The key elements of the definition include:

•

who is the 'provider' and who is the 'client'. It is noted that the client must be a natural person, which excludes all lending to corporate entities from the definition [Schedule 1, item 9, paragraph 761EA(2)(a)];

•

a requirement that the borrower must use the loan (wholly or partly) to acquire shares or other financial products [Schedule 1, item 9, subparagraph 761EA(2)(b)(i)] or to refinance a margin lending facility [Schedule 1, item 9, subparagraph 761EA(2)(b)(ii)];

•

that the loan must be wholly or partly secured over shares or other defined securities ('marketable securities'). 'Marketable securities' is defined by existing section 9 of the Corporations Act [Schedule 1, item 9, paragraphs 761EA(2)(c) and (d)]; and

•

that the client is subject to a 'margin call' in circumstances where the 'current LVR' of the facility exceeds the agreed threshold [Schedule 1, item 9, paragraph 761EA(2)(e)].

1.44 The current LVR is defined as the ratio of the outstanding debt to the security provided for the loan. [Schedule 1, item 9, subsection 761EA(3)]

1.45 This means that a 'margin call' can occur where the value of the securities underlying the loan falls below a certain critical level due to adverse market movements or where the customer draws down too far on the loan. The critical level may include a buffer granted by the provider, provided it forms part of the terms of the facility. [Schedule 1, item 9, subsection 761EA(4)]

Example 1.1 : Example of a margin loan

An example is provided to assist in understanding the definition and how a margin call operates:

•

Loan amount - $85,000.

•

Original value of the secured property - $125,000 (the value of property provided by the client as security, which must include some marketable securities, and which may (but need not) include some or all of any financial products purchased by the client with the loan).

•

Margin call occurs if the current LVR is above 80%.

•

Original current LVR = 85,000/125,000 = 68%.

•

Value of the secured property falls to $100,000.

•

Current LVR = 85,000/100,000 = 85%.

•

Facility is in margin call on the date the current LVR exceeds 80%.

1.46 Due to the way the definition is framed, certain types of investment and other loans are excluded from its scope.

Use of the loan

1.47 In order for a loan to be a margin lending facility for the purposes of Chapter 7 of the Corporations Act (and the Corporations Agreement), the purpose and use of the loan must be investment related in a particular manner as defined in the Bill.

1.48 Subparagraph 761EA(2)(b)(i) requires that the loan must be partly or wholly used for the purchase of, or beneficial interest in, financial products. This means that this use of the loan must form part of the terms of the margin loan facility. [Schedule 1, item 9, subparagraph 761EA(2)(b)(i)]

Investment lending

1.49 General investment lending is intended to be excluded from the definition of a margin loan facility. Other forms of investment lending more generally will be addressed in phase two of the Commonwealth's assumption of responsibility for the regulation of consumer credit.

Example 1.2 : Examples of excluded investment lending

•

A loan secured against a residential or investment property and used to purchase securities is an investment loan.

•

Where general consumer lending (such as a personal loan or credit card) is wholly used to purchase an investment product (financial product). If it is partly used to purchase an investment product, the loan is a consumer loan and will be regulated under the consumer credit legislation.

1.50 Alternatively, the definition is not intended to capture margin loans used solely for personal, domestic or household use, or (non-investment) business purposes.

Example 1.3 : Examples of excluded lending

•

Where the only use of a margin loan is for the purchase of a product or service for personal, domestic or household use, such as the purchase of travel or a car. In this circumstance, it is expected that either the lender does not provide the loan, or that they provide the loan under an Australian credit licence.

•

Where the only use of a margin loan is to purchase assets for a farming business (business purpose).

Non-standard margin lending facilities

1.51 The type of margin loan targeted by the definition of a 'non-standard margin lending facility' is not based on a loan agreement, but uses a type of securities lending agreement (with variations) to achieve a similar economic outcome as would a standard margin loan.

1.52 General 'stock' or securities lending, particularly in the wholesale market, is not intended to be included in this definition.

1.53 This type of structure was used by lenders such as Opes Prime and Tricom and provided as a 'margin loan', 'equity finance' or 'securities finance'. The key difference, from the client's point of view, is that in a non-standard margin loan, title to the security provided for the loan passes out of the client's hands. This key aspect of a non-standard margin loan is captured in the definition.

1.54 Subsection 761EA(5) sets out the definition of a non-standard margin loan [Schedule 1, item 9, subsection 761EA(5)]. The key elements of the definition include:

•

determining who the provider is and who the client is in the context of transferred securities. It is noted that the client must be a natural person, which excludes all lending to corporate entities from the definition [Schedule 1, item 9, paragraph 761EA(5)(a)];

•

the client receives 'transferred property'. Transferred property is the equivalent arrangement to the provision of credit or cash in a standard margin lending facility. It may sometimes be referred to as collateral for the 'transferred securities' [Schedule 1, item 9, paragraph 761EA(5)(b];

•

the funds provided to the client must, as in the case of a standard margin lending facility, be at least partly used to acquire financial products. This is intended to ensure that only facilities are captured which have a similar outcome to a standard margin loan [Schedule 1, item 9, paragraph 761EA(5)(c)]; and

•

the client is subject to a margin call in circumstances where the current LVR of the facility exceeds the agreed threshold [Schedule 1, item 9, paragraph 761EA(5)(e)].

1.55 Non-standard margin loans also operate on the basis of margin calls, which occur when the LVR exceeds an agreed threshold. The definitions of 'margin call' [Schedule 1, item 9, subsection 761EA(7)] and 'current LVR' [Schedule 1, item 9, subsection 761EA(6)] for a non-standard margin lending facility are similar to those for a standard margin lending facility, with some amendments to suit the special characteristics of non-standard margin loans.

Example 1.4 : Example of a non-standard margin loan

An example is provided to assist in understanding the scope and intent of the definition:

•

Value of the transferred property given by the provider to the client = $85,000 (equivalent to the loan amount in a standard loan).

•

Value of the transferred securities transferred by the client to the provider = $125,000 (value of the marketable securities transferred by the client to the provider, which may (but need not) include some or all of any marketable securities purchased with the loan).

•

Margin call occurs if the current LVR is above 80%.

•

Original current LVR = 85,000/125,000 = 68%.

•

Value of the transferred securities falls to $100,000.

•

Current LVR = 85,000/100,000 = 85%.

•

Facility is in margin call on the date the current LVR exceeds 80%.

1.56 The operation of the definition of a non-standard margin lending facility in the manner outlined in the example above is quite different from a general 'stock' or securities lending transaction.

1.57 In the case of a general 'stock' or securities lending transaction, the cash collateral (or the value of any non-cash collateral) usually must always exceed the value of the transferred securities (that is, the ratio must normally be in excess of 100 per cent, say 102 per cent), and margining will be required if the ratio falls below the agreed minimum of say 102 per cent.

Example 1.5 : Example of normal stock lending arrangements

An example of a general stock or securities lending transaction is provided to assist in understanding the difference from the transactions captured by the definition:

•

Value of cash or non-cash collateral provided by securities borrower to securities lender = $105,000.

•

Value of borrowed securities = $100,000.

•

Margining by the securities borrower is required if the value of the collateral becomes less than the agreed ratio of the value of the collateral to the value of the borrowed securities, which say is agreed at 102%.

Scenario A

•

Value of the borrowed securities rises to $125,000.

•

New ratio = 105,000/125,000 = 84%.

•

The securities borrower must provide extra collateral of (or worth) at least $22,500, so that the value of the collateral is at least $127,500, and the ratio increases to at least a minimum of 102%.

Scenario B

•

Contrast the situation if the value of the borrowed securities falls to say $85,000.

•

The new ratio = 105,000/85,000 = 123.5%.

•

That would not trigger any margining requirement on the part of the securities borrower. (On the contrary, the securities borrower may be entitled to call for the return of some or all of the excess collateral that it has provided, until the new ratio falls to not less than 102%.)

ASIC may declare facilities to be margin lending facilities

1.58 ASIC has the power to declare that a particular kind of facility is, or is not, a margin loan. In declaring a kind of facility as a margin loan, ASIC must also define key features such as a 'margin call' in the context of the facility. These powers are necessary to deal with product innovation and the likelihood that over time new margin loan structures will evolve that may not be captured by the current definition, such that the relevant investor protection provisions continue to apply. [Schedule 1, item 9, subsections 761EA(8) to (10)]

1.59 A declaration that a particular kind of facility is, or is not, a margin loan under subsection 761EA(8) or (9) must be in writing and is a legislative instrument for the purposes of the Legislative Instruments Act 2003 (Legislative Instruments Act).

Meaning of limit of a margin lending facility

1.60 The meaning of the key term 'limit' is given a specific definition in the case of standard and non-standard margin loans. For standard margin loans, the limit means the maximum amount of credit under the loan agreement, while for a non-standard loan it means the maximum amount of property that may be transferred by the provider to the client under the terms of the agreement. It is also stipulated that ASIC must define the term if it declares that something is a margin lending facility. [Schedule 1, item 9, subsection 761EA(11)]

Responsible lending for margin lending facilities

1.61 Subdivision A, Division 4A of Schedule 1 sets in place responsible lending requirements. The responsible lending provisions are intended to be broadly consistent with the provisions outlined in the National Consumer Credit Protection Bill 2009. However, there are some differences to take into account the specific nature of a margin loan.

Requirement to make assessment of unsuitability

1.62 Margin lenders are required, before issuing a loan or increasing the limit of an existing loan, to make an assessment to determine whether the loan facility is unsuitable for a 'retail client' [Schedule 1, item 12, section 985E]. 'Retail client' is defined in existing section 761GA of the Corporations Act. It is noted that this requirement only applies to lenders, and not to advisers.

1.63 Before issuing a new margin loan or increasing the limit of an existing loan, the lender must make an unsuitability assessment as set out in detail in section 985F. The assessment must be made within 90 days before the loan is issued or the limit increased, or any other period as prescribed in regulations. The assessment must cover the period during which the issue or limit increase occurs. At the time the assessment is made, the person doing the assessment should ask the consumer when it is expected that they intend to obtain the loan or limit increase - usually by reference to a future period rather than a precise date (for example, in the next two weeks, or in July or August). Assessments are to be made on that basis. The purpose of this section is to ensure that assessments are not used if they were prepared with a view to the loan being advanced in a different period to that in which the loan is actually issued or limit is increased. The lender must also have made the inquiries and verification as set out in detail in section 985G. Failure to make an assessment as required incurs a civil penalty. [Schedule 1, item 12, subsection 985E(1)]

1.64 Provisions are included that clarify that an increase in a credit limit that occurs because of changes in the market value of the underlying security does not require an unsuitability assessment to be made. [Schedule 1, item 12, subsection 985E(2)]

1.65 A regulation-making power is included allowing other situations to be defined in which a limit increase is considered to have occurred or not to have occurred. Concerns have been raised during consultation about the possibility of circumstances occurring where a borrower breaches the agreed credit limit through actions that are beyond the control of the loan provider. It is intended to use this regulation-making power to address such situations before the commencement of the new regime. The regulation-making power could also be used to address other situations where the strict application of the requirement to make an unsuitability assessment may not be justified, or where it is considered necessary to apply the requirement to circumstances that do not fall within the current scope of the provision. [Schedule 1, item 12, subsection 985E(3)]

Unsuitability assessment

1.66 The unsuitability assessment must be made if the margin loan facility is issued or the loan limit increased, and must specify the period it covers. If no loan facility is issued, or no limit increased, no assessment is required to be made. This is considered to be appropriate as the misconduct that is intended to be addressed by this provision relates to clients that are placed into margin loans that may be unsuitable for them. If the loan is not provided there is evidently no risk of such harm affecting the client. [Schedule 1, item 12, section 985F]

Reasonable inquiries etc. about the retail client

1.67 In making an assessment, margin lenders are required to make reasonable inquiries about the client's financial situation and take reasonable steps to verify it [Schedule 1, item 12, paragraphs 985G(1)(a) and (b)]. This includes any inquiries or verification steps prescribed by regulations [Schedule 1, item 12, paragraphs 985G(1(c) and (d)], and must be made in a manner prescribed (if prescribed by regulations) [Schedule 1, item 12, subsection 985G(2)].

1.68 The purpose for undertaking reasonable inquiries about the client's financial situation is to obtain an understanding of the client's ability to meet all the repayments, fees, charges and transaction costs of complying with a possible margin call. The general position is that clients should be able to meet their contractual obligations from income and available liquid assets, rather than from long-term savings or from equity in a fixed asset such as a residential home. The returns that are potentially available from the portfolio financed by the loan may be taken into account in a reasonable manner, but should not constitute the sole or main source of funds available to meet a margin call and service the margin loan.

1.69 As a general rule, reasonable inquiries about the consumer's financial situation should be expected to include determining the amount and source of the consumer's gross and disposable incomes, the reliability of the income and the availability of assets, in particular liquid assets, to meet demands for additional payments such as a margin call. The detailed nature of these inquiries may differ depending on the borrower and their circumstances.

1.70 Regulations will be made to prescribe specific matters that lenders must take into account, which are intended to include important considerations such as whether clients have taken out a second loan to finance their equity contribution for the margin loan, and whether they have used their homes to secure this second loan. This creates a scenario known as 'double gearing' which may in some situations lead to the risk of clients losing their homes, if they are unable to service their loans following a margin call.

1.71 It is therefore important for lenders to have assessed the potential impact of such factors on a client's position before deciding to provide a margin loan. Particular attention should be paid to the risk of a client losing their residential home as a consequence of being unable to service or repay the margin loan.

1.72 In undertaking the assessment lenders are required to take into account information about the client's financial situation and other matters required by the regulations that they either already possess, or which would be known to them if they made reasonable inquiries and took reasonable steps to verify it. Where lenders are unable to access information, for example because of rules quarantining information within business units, this would clearly fall outside the scope of the reasonable inquiries expected to be made.

1.73 This provision also requires lenders to take reasonable steps to verify the information they have obtained. This is intended to mean that lenders must make such efforts to verify the information provided by the client as they would undertake in the normal course of their business. Conducting a credit check is, for instance, considered to be an action undertaken by lenders in the normal course of their business.

1.74 As the responsible lending provisions impose new requirements on margin lenders, current business practice for margin lending may not in all circumstances be sufficient to satisfy the need to take reasonable steps to verify information. In such situations, reference may have to be made to practices applied in other credit areas.

1.75 It is noted that there will be matters that will not be able to be known to the credit provider. This may arise where the consumer simply does not disclose the matter, despite the credit provider's inquiry, and where there was no reasonable way of verifying the information provided.

1.76 ASIC will also provide guidance where appropriate to set out further detail about reasonable inquiries and the verification process in particular circumstances.

Reliance on information provided in a statement of advice

1.77 In making reasonable inquiries, lenders may rely on information provided in a statement of advice for the client, where the statement of advice recommends the margin lending facility, and it was prepared no more than 90 days before the day on which the margin lending facility is proposed to be entered into. In these circumstances, the provider is not required to verify such information. [Schedule 1, item 12, subsection 985G(3)]

1.78 This reliance provision is intended to minimise the regulatory burden on lenders and the impost on consumers, where the same information has already been provided to an adviser.

1.79 It is, however, noted that lenders cannot solely rely on the information provided in a Statement of Advice (SoA) where that information does not satisfy the benchmark of having to make reasonable inquiries about the client's financial situation. In those circumstances lenders would have to make inquiries to obtain additional information in order to comply with the benchmark.

1.80 It is envisaged that margin lenders could make arrangements for information relevant to a margin loan to be excerpted from an SoA and presented to them in a particular format. Lenders will have to obtain appropriate confirmation that any information excerpted in this way forms part of an SoA, including the date of the SoA.

When margin lending facility must be assessed as unsuitable

1.81 Guidance is provided as to when a margin loan must be assessed as unsuitable [Schedule 1, item 12, section 985H]. Clarification is provided that lenders may reject loan applications for reasons other than those mentioned in the legislation [Schedule 1, item 12, subsection 985H(1)].

1.82 A loan is unsuitable where a client who receives a margin call would not be able to comply with their financial obligations around a margin call, or would only be able to do so while suffering substantial hardship [Schedule 1, item 12, paragraph 985H(2)(a)]. A power is provided to prescribe specific situations where a loan must be assessed as unsuitable. It is intended to prescribe a number of such situations, subject to further consultation and consideration, before the regime commences [Schedule 1, item 12, paragraph 985H(2)(b)].

1.83 The assessment is to be based on the facts as they have been obtained by the provider or are otherwise available to the provider at the time of making the assessment. There is no requirement for providers to make assumptions about potential future developments.

1.84 In making the assessment, lenders must take into account information concerning the client's financial situation, as well as other matters prescribed by regulations. It must also be information which the lender has reason to believe was true, or would have had reason to believe that the information was true, if it had made the inquiries or verification required. Information that does not satisfy these requirements must not be taken into account. [Schedule 1, item 12, subsection 985H(3)]

1.85 The assessment conducted by the lender must specifically address the ability of the client to cope with the potential consequences of a margin call, in particular the possibility of having to deal with negative equity situations. An important factor in the assessment is the time allowed to the client to meet the margin call. Where clients are allowed only a short period within which the margin call must be met, the importance of the client having sufficient liquid assets to cope with such situations is enhanced. It is not intended that the potential sell-down of part or all of the portfolio to adjust the LVR to the required level should imply substantial hardship.

Giving the retail client the assessment

1.86 Clients may request the lender to provide them with a written copy of the assessment, but only if the request is made within seven years after the loan is issued or the loan limit increased. [Schedule 1, item 12, section 985J]

1.87 Failure to give the client a copy of the assessment is an offence (50 penalty units) and incurs a civil penalty. [Schedule 1, item 12, subsection 985J(1)]

1.88 Lenders do not have to give the client the written assessment if the loan is not issued or the credit limit not increased. [Schedule 1, item 12, subsection 985J(1), note 3]

1.89 Appropriate time limits for providing the assessment are imposed. If the request is made before the loan is issued or the limit increased, then the copy must be provided before the agreement is finalised. If the request is made after the arrangements are finalised, the copy must be provided within seven business days if the request is made within two years after the loan is issued or the limit increased. Requests made later than that must be addressed within 21 business days. Failure to comply with these requirements is an offence (50 penalty units) and also incurs a civil penalty. [Schedule 1, item 12, subsection 985H(2)]

1.90 The provider must give a copy of the assessment in a manner (if any) prescribed by regulations. [Schedule 1, item 12, subsection 985J(3)]

1.91 This assessment must be given to the client without charge. It is an offence (50 penalty units) and incurs a civil penalty to make a client pay for the assessment. [Schedule 1, item 12, subsection 985J(4)]

1.92 Subsections 985J(1), (2) and (4) are offences of strict liability, because it is considered that these offences should attract criminal sanctions where there is no 'fault' but for the failure to provide the assessment as required by the law. This is based on the relatively low penalty amount and the need to include a deterrent for breaches of these provisions. [Schedule 1, item 12, subsection 985J(5)]

Unsuitable margin lending facilities

1.93 Lenders must not provide a new loan or increase in the limit of an existing loan where the loan or increase is unsuitable for the client [Schedule 1, item 12, section 985K]. Failure to comply with this requirement attracts a civil penalty and is also a criminal offence carrying a maximum penalty of 100 penalty units, two years imprisonment or both [Schedule 1, item 12, subsection 985K(1)]. Providing a client with an unsuitable margin loan is the main 'harm' these provisions are intended to address.

1.94 The same unsuitability definitions and other requirements apply as described above in relation to sections 985E and 985H. These amendments specify when a facility is unsuitable, what information the provider must base the assessment on, and exempt a particular situation from the definition of an increase in the limit of a facility. [Schedule 1, item 12, subsections 985K(2) to (6)]

1.95 A regulation-making power is provided allowing particular situations to be prescribed in which a margin lending facility is not taken to be unsuitable. [Schedule 1, item 12, subsection 985K(4)]

Notification of margin calls

Issuer must notify client of margin call

1.96 Subdivision B, Division 4A sets in place a requirement that the lender must make reasonable efforts to notify the client when a margin call occurs. [Schedule 1, item 12, subsection 985M(1)]

1.97 Lenders are allowed to make use of a buffer before issuing margin calls to borrowers, as this is a useful practice for accommodating short-term fluctuations in market values. As mentioned above, this requires the buffer to be part of the terms of the facility.

When issuer must notify client's agent, and agent must notify client, of margin call

1.98 A lender may notify a financial adviser, instead of the client, based on contractual arrangements agreed to by the relevant parties.

1.99 If there is an agreement between the lender, the client, and a financial adviser ('the agent') that 'the agent' will act on behalf of the client, then [Schedule 1, item 12, subsection 985M(2)]:

•

the lender must make reasonable efforts to notify the agent; and

•

the agent must make reasonable efforts to notify the client.

1.100 Failure to comply with the notification requirements, under both subsections 985M(1) and (2), incurs a civil penalty.

When and how notification must be given

1.101 The notification of a margin call must be given at a time determined by ASIC. If ASIC has not prescribed a time, then the notification must be provided as soon as practicable. [Schedule 1, item 12, subsection 985M(3)]

1.102 The notification must be given in a manner agreed between the parties, or, if there is no such agreement, in a manner determined by ASIC. If ASIC has not prescribed a manner, then the notification should be provided in any reasonable manner that would satisfy the objective of ensuring that the client receives the notification in a timely fashion. [Schedule 1, item 12, subsection 985M(4)]

1.103 'Reasonable manner' is considered to include electronic means such as the telephone, facsimile, SMS and email. Notification through a client's individual account which is accessed by means of the client logging on through the lender's website alone is generally not considered to be a 'reasonable manner', unless the client is simultaneously alerted through other means that an important notice has been placed in their account.

1.104 ASIC can determine the time and manner in which notification is to occur. This determination by ASIC must be in writing and is a legislative instrument for the purposes of the Legislative Instruments Act. [Schedule 1, item 12, subsections 985M(5) and (6)]

Margin lending facility not to be conditional on notification arrangements

1.105 Making arrangements to notify the agent in the event of a margin call should not be a condition of entering into a margin lending facility. Such a contravention attracts a civil penalty. [Schedule 1, item 12, section 985L]

General amendments

1.106 Amendments are made ensuring that the provisions in section 1016A of the Corporations Act relating to the use of application forms and in section 1017D in relation to the provision of periodic statements apply to margin loans. [Schedule 1, items 13 and 14]

1.107 Amendments are made applying the civil penalty provisions in section 1317E of the Corporations Act as described in various parts of this explanatory memorandum to the Bill. [Schedule 1, item 15]

1.108 The penalties for breaching the responsible lending requirements are inserted in the list of penalties for offences in Schedule 3 to the Corporations Act. [Schedule 1, item 16]

Application and transitional provisions

1.109 Division 1 of Part 10.12 of the Corporations Act contains the transitional arrangements for the amendments in the Bill relating to margin loans.

1.110 A number of key definitions are specified in relation to the transitional arrangements for the national margin lending regime. [Schedule 5, Division 1, section 1487]

1.111 The Corporations Act will apply to issuing and advising by margin lenders and financial advisers in relation to margin loans twelve months after the legislation comes into force. This period will give potential licensees time to prepare for the new regime by adapting their systems and processes, training staff and in other necessary ways. It is noted that issuance and advice are only captured insofar as they relate to margin loans issued after commencement of the Bill. [Schedule 5, Division 1, section 1488]

1.112 Applications to ASIC for obtaining a licence are not to be made until one month after the legislation comes into force. This period is designed to provide ASIC with time to prepare for receiving and processing applications. [Schedule 5, Division 1, subsection 1489(1)]

1.113 The transitional arrangements enable persons to apply for AFSLs and ASIC to issue or vary licences thereafter until the Chapter 7 regime including the new amendments comes into force 12 months after commencement of the legislation. Any AFSL, or variation of an AFSL, granted by ASIC does not take effect until 12 months after commencement. [Schedule 5, Division 1, subsections 1489(1) to (3)]

1.114 During the period from 6 to 12 months after commencement, lending and advising in relation to margin loans may only be done by persons who have applied to ASIC for a licence or a variation to an existing licence allowing them to provide these services. ASIC is also given the power to reject a licence application during this period if it considers the application to be unsuitable. This power is required as such applicants could otherwise provide the services until the new regime comes into force 12 months after commencement. [Schedule 5, Division 1, section 1490]

1.115 It is not anticipated that the Bill (or instruments made under it) effects any acquisition of property other than on just terms contrary to paragraph 51(xxxi) of the Constitution. A relevant clause is included out of an abundance of caution to ensure that an acquisition contrary to paragraph 51(xxxi) cannot take place. In any circumstance where an acquisition contrary to paragraph 51(xxxi) is effected, the relevant law or instrument does not apply. This clause overrides section 1350 of the Corporations Act which contains provisions relating to the payment of compensation due to the acquisition of property otherwise than on just terms. [Schedule 5, Division 1, section 1491]

1.116 Regulations may be made prescribing matters of a transitional, application or saving nature relating to the legislation. This power is considered necessary to deal with unexpected or minor transitional matters arising after the legislation is passed. [Schedule 5, Division 1, section 1492]

Chapter 2 - Regulation of trustee companies

Outline of chapter

2.1 Schedule 2 to the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 (Bill) inserts Chapter 5D (Licensed trustee companies) into the Corporations Act 2001 (Corporations Act). Chapter 5D implements the transfer of trustee company regulation from the States and Territories to the Commonwealth.

2.2 Chapter 5D creates a national licensing regime for trustee companies, thereby reducing the regulatory burden on those companies and creating a national market for trustee services, thus delivering competition benefits to the industry. Chapter 5D also protects consumers by establishing a national consumer protection and disclosure regime under the Corporations Act and the Australian Securities and Investments Commission Act 2001 (ASIC Act).

Context of amendments

2.3 In July 2008, the Council of Australian Governments (COAG) agreed that the Commonwealth would assume responsibility for the regulation of trustee companies. In October 2008, COAG agreed that legislation giving effect to Commonwealth regulation of trustee companies would be introduced in the first half of 2009.

2.4 The private trustee company industry is relatively small with ten licensed private trustee companies. The majority of these trustee companies are licensed and operate in multiple jurisdictions. There are also eight public trust offices.

2.5 Trustee companies have been regulated at an entity level under State and Territory regulatory regimes. The State and Territory laws also allow private trustee companies to enter the market for personal trustee and estate administration work (for example, acting as an executor or administrator of a deceased estate), thereby removing the limitation that these duties could only be undertaken by natural persons. In addition, State and Territory laws facilitate the establishment of long term and perpetual trusts, such as charitable trusts.

2.6 As the majority of trustee companies operate in multiple jurisdictions, the need to obtain a licence in each individual State and Territory, combined with the lack of consistency in licensing requirements, creates barriers to entry and restricts competition in the marketplace.

2.7 It is important to note that the Schedule regulates the provision of the so-called 'traditional trustee company services' of trustee companies. These services are listed in section 601RAC. Where trustee companies provide other services, such as acting as a superannuation trustee, acting as a Responsible Entity for managed funds, providing a custodial or depository service, or acting as a trustee for debenture holders, they must comply with Commonwealth legislation, such as the Superannuation Industry (Supervision) Act 1993 and Chapter 7 of the Corporations Act.

2.8 In order to offer funds management services, all of the private trustee companies hold Australian financial services licence (AFSLs). As a result, they are familiar with regulation by the Australian Securities and Investments Commission (ASIC) and the requirements of an AFSL.

2.9 Broadly, the policy intent is that the Commonwealth will have exclusive responsibility for 'entity level' regulation of trustee companies' traditional services, including licensing those companies and regulating the fees they can charge for those traditional services. At the same time, State and Territory legislation, and the rules of common law and equity, will continue to govern the functions and powers of trustee companies. Also, it is intended to preserve rules which apply generally to persons such as trustees, executors, administrators and guardians (including trustee companies when they perform those roles).

2.10 In the place of the differing State and Territory regimes, Schedule 2 creates a single licensing and reporting regime administered by a single regulator (ASIC). Trustee companies which provide 'traditional trustee company services' will be required to hold an AFSL covering the provision of those services. Further, trustee companies will be subject to the disclosure, conduct, advice and dispute resolution arrangements under the Corporations Act, as modified where necessary by regulations made under the Corporations Regulations 2001 (regulations).

2.11 Also, this legislation introduces a single regime for the disclosure and regulation of fees charged by trustee companies. Most jurisdictions have set caps on the level of fees, but these are not uniform. Two jurisdictions (Western Australia and the Australian Capital Territory) do not cap fees.

2.12 Concerns have also been expressed about the need for more cost effective and timely alternative dispute resolution mechanisms for beneficiaries to enhance the protection available for trust assets. Currently, in the absence of internal dispute resolution services voluntarily provided by the trustee company, the Supreme Court is the only avenue of recourse for beneficiaries with concerns about the management of the trust or estate.

2.13 The legislative power to make this Commonwealth law is primarily derived from section 51(xx) of the Constitution, which empowers the Commonwealth to make laws with respect to 'foreign corporations, and trading or financial corporations formed within the limits of the Commonwealth'. The Commonwealth is relying on its legislative powers, rather than seeking a referral of power from the States.

Summary of new law

2.14 The Bill sets out:

•

when trustee companies are regulated by Chapter 5D, including key concepts such as licensed trustee company, client of a trustee company and traditional trustee company services, and services that are regulated (Part 5D.1);

•

the effect of the Bill on the jurisdiction of courts and the continuing operation of State and Territory laws (Part 5D.2, Division 1)

•

the powers and obligations of licensed trustee companies, in relation to the provision of accounts and the establishment and operation of common funds (Part 5D.2, Divisions 2 and 3);

•

the regulation of fees charged by licensed trustee companies (including fee disclosure) (Part 5D.3);

•

the duties of officers and employees of licensed trustee companies (Part 5D.4);

•

a 15 per cent voting power limit on control of licensed trustee companies (Part 5D.5);

•

the consequences of cancelling a licensed trustee company's AFSL (Part 5D.6); and

•

exemptions and modifications by ASIC, and by regulations (Part 5D.7).

Comparison of key features of new law and current law

Detailed explanation of new law

2.15 These provisions bring trustee companies (when they perform traditional trustee company services) into the consumer protection regime for financial services set out in Chapter 7 of the Corporations Act and in the ASIC Act. This means that, subject to modifications, trustee companies must comply with the licensing, conduct, disclosure, advice dispute resolution and compensation requirements of Chapter 7.

Jurisdictional scope

2.16 Chapter 5C is subject to the general territorial application of the Corporations Act - that is, it applies 'in this jurisdiction' (subsection 5(3)). Following the definition of this jurisdiction in subsection 5(1), Chapter 5C applies throughout mainland Australia.

Part 5D.1 - Preliminary

Key concepts and definitions

Regulation of trustee companies

2.17 The regulation of trustee companies under Chapter 5D applies to a 'licensed trustee company'.

2.18 A trustee company is a company:

•

that is a constitutional corporation [Schedule 2, item 9, paragraph 601RAB(1)(a)]; and

•

that is prescribed by the regulations as a trustee company for the purposes of the Act [Schedule 2, item 9, paragraph 601RAB(1)(b)].

2.19 Companies may (for example) be prescribed:

•

by setting out a list of companies in the regulations [Schedule 2, item 9, paragraph 601RAB(2(a)]; or

•

by providing a mechanism in the regulation for the determination of a list of companies [Schedule 2, item 9, paragraph 601RAB(2)(b)].

Example 2.1

For example, the regulations could specify that a corporation that is authorised to apply for a grant of probate or letters of administration, of the estate of a deceased person, must be listed.

2.20 A licensed trustee company is a trustee company that holds an AFSL covering the provision of 'traditional trustee company services'. [Schedule 2, item 9, section 601RAA]

2.21 As traditional trustee company services are financial services for the purpose of Chapter 7 (see proposed subsection 766A(1A) at Schedule 2, item 19), a trustee company will be required to hold an AFSL to provide those services.

Services covered by this chapter

2.22 The regulation of licensed trustee companies only applies to traditional trustee company services. Traditional trustee company services fall into two categories:

•

preparing certain documents (such as a will or trust instrument), applying for certain authorisations (such as probate), and establishing and operating a common fund [Schedule 2, item 9, subsection 601RAC(1)]; and

•

estate management functions, which involve acting in certain formal roles, such as a trustee, executor, attorney, guardian or receiver [Schedule 2, item 9, subsection 601RAC(2)].

2.23 The overall effect is that a trustee company must be listed as a trustee company, and must hold an AFSL granted by ASIC, with that AFSL covering the provision of 'traditional trustee company services'.

2.24 The Chapter applies to all trustee companies that are listed in the Schedule and that hold an AFSL covering the provision of traditional trustee company services. This is subject to the proviso that public trust offices are only covered by the Chapter if they (and the relevant State/Territory) explicitly opt to be covered.

Services that are not covered by this chapter

2.25 Trustee companies provide a wide range of services, including services that are not covered by the definition of 'traditional trustee company services'. To ensure there is no overlap and such services are not covered by Chapter 5C, the Chapter does not apply to:

•

operating a registered scheme (under Chapter 5C);

•

providing a custodial or depository service (within the meaning of section 766E);

•

acting as trustee for debenture holders under Chapter 2L;

•

acting as a receiver or other controller of property of a corporation under Part 5.2;

•

acting as trustee of a superannuation fund, an approved deposit fund or a pooled superannuation trust (within the meaning of the Superannuation Industry (Supervision) Act 1993); or

•

acting in any other capacity prescribed by the regulations.

[Schedule 2, item 9, subsection 601RAC(3]

Meaning of ' client'

2.26 A client of a trustee company is a person to whom, within the meaning of Chapter 7 of the Corporations Act, a financial service (that is, a traditional trustee company service) is provided by the trustee company. Regulations made for the purpose of subsection 766A(1B) may define who is a client of a trustee company. [Schedule 2, item 9, section 601RAA and subsection 601RAB(3)]

Meaning of ' court' and ' Court'

2.27 These terms are defined in existing section 58AA of the Corporations Act. While court means any court , Court relevantly includes the Federal Court and the Supreme Court of a State or Territory. It is envisaged that the State and Territory Supreme Courts would continue to exercise their traditional functions, albeit (where such functions are covered by the Schedule) as an exercise of Federal jurisdiction by a State court.

Meaning of ' person with a proper interest'

2.28 The concept of a person with a proper interest, in relation to an estate, is defined in section 601RAD as including a number of persons and entities, both generally and in the case of charitable trusts, other trusts and deceased estates. [Schedule 2, item 9, section 601RAD]

Other key definitions

2.29 Fees are defined broadly to include fees in the nature of remuneration (including commissions), to ensure the definition accords with other references to fees in the Corporations Act (for example, in paragraph 942B(2)(e)). [Schedule 2, item 9, section 601RAA]

2.30 A law means a law of the Commonwealth or of a State or Territory, and includes a rule of common law or equity. This definition mainly affects breach notification requirements. [Schedule 2, item 9, section 601RAA]

2.31 The term publish picks up any references in regulations to publishing requirements. [Schedule 2, item 9, section 601RAA]

2.32 A will includes a codicil and other testamentary writing. [Schedule 2, item 9, section 601RAA]

2.33 The term estate is not defined in the legislation, but takes its meaning from section 22 of the Acts Interpretation Act 1901 as including 'any estate or interest charge right title claim demand lien or incumbrance at law or in equity'.

Interaction between trustee company provisions and State and Territory laws

2.34 A major objective of this reform is to ensure that, as far as possible, trustee companies are not subjected to multiple or overlapping regulatory regimes.

2.35 Section 601RAE sets out the areas of law in which the trustee company provisions (as defined in subsection (1)) are intended to operate exclusively. They are laws that:

•

authorise or license companies to provide traditional trustee company services generally (as opposed to laws that authorise or license companies to provide a particular traditional trustee company service);

•

regulate the fees that may be charged by companies for the provision of traditional trustee company services, and laws that require the disclosure of such fees;

•

deal with the provision of accounts by companies in relation to traditional trustee company services that they provide;

•

deal with the duties of officers or employees of companies that provide traditional trustee company services;

•

regulate the voting power that people may hold in companies that provide traditional trustee company services, or that otherwise impose restrictions on the ownership or control of companies that provide traditional trustee company services;

•

deal with what happens to assets and liabilities held by a company, in connection with the provision by the company of traditional trustee company services, if the company ceases to be licensed or authorised to provide such services. (This does not apply to laws referred to in section 601WBC, that is, complementary State and Territory legislation to give effect to transfers of estate assets and liabilities.)

[Schedule 2, item 9, subsection 601RAE(2)]

2.36 The section explicitly notes that the Commonwealth provisions are not intended to exclude State or Territory laws that require a company, or its staff, to have particular qualifications or experience. The section also explicitly states that complementary State or Territory statutes giving effect to compulsory transfer determinations under Part 5D.6 are not excluded. [Schedule 2, item 9, subsection 601RAE(3)]

2.37 There is a specific regulation-making power to provide that the trustee company provisions are, or are not, intended to exclude prescribed State or Territory laws. [Schedule 2, item 9, subsection 601RAE(4)]

2.38 Part 1.1A, which ordinarily sets out the relationship between the Corporations Act and State and Territory legislation, does not apply in relation to the trustee company provisions. [Schedule 2, item 9, subsection 601RAE(6)]

Part 5D.2 - Powers etc. of licensed trustee companies

2.39 Part 5D.2 broadly deals with two matters. First, it deals with the effect of Schedule 2 on the jurisdiction of courts and the continuing operation of State and Territory laws [Schedule 2, item 9, Part 5D.2, Division 1]. Secondly, it sets out the powers and obligations of licensed trustee companies in relation to the provision of accounts and the establishment and operation of common funds. [Schedule 2, item 9, Part 5D.2, Divisions 2 and 3]

2.40 In the past, only natural persons were able to provide personal trustee and estate administration services. While this obstacle has been removed by State and Territory laws, it should also be noted that, under subsection 124(1) of the Corporations Act, a company has the legal capacity and powers of an individual both in and outside this jurisdiction.

Division 1 - General provisions

2.41 Part 5D.2 does not affect the inherent power or jurisdiction of courts to supervise the performance of traditional trustee company functions. A licensed trustee company is subject in all respects to the same control and general jurisdiction of courts in the same way as any other person who performs traditional trustee company functions. Under subsection 58AA(1) of the Corporations Act , court means any court. [Schedule 2, item 9, section 601SAA]

2.42 In addition to the powers, functions, liabilities and obligations, and such privileges and immunities, which a licensed trustee company has under these provisions, the company also has such other powers etc. as are prescribed by the regulations. [Schedule 2, item 9, section 601SAB]

2.43 The functions, powers, liabilities and obligations, and the privileges and immunities, conferred or imposed, on licensed trustee companies by this Part are in addition to, any functions and powers, under any other law (law is defined in section 601RA to mean Commonwealth, State or Territory laws or a rule of common law or equity). This provision is intended to permit the concurrent operation of State and Territory laws that confer powers on trustees, executors, guardians etc. [Schedule 2, item 9, section 601SAC]

Division 2 - Accounts

2.44 These provisions specify circumstances in which:

•

a licensed trustee company is not required to file accounts relating to an estate, or may be required to provide an account in relation to an estate; and

•

the Court may order an audit of an estate, and requirements to make documents available.

Licensed trustee company not required to file accounts

2.45 A licensed trustee company, when acting alone in relation to any estate of a deceased person, is not required to file, or file and pass, accounts relating to the estate unless ordered to do so by the Court. While Court is defined in subsection 58AA(1), it is envisaged that the State and Territory Supreme Courts would continue to exercise this role. A licensed trustee company acting jointly with another person also does not have to file, or file and pass, account relating to the estate unless the other person intends to charge fees for its role, or so ordered by the Court. [Schedule 2, item 9, section 601SBA]

Licensed trustee company may be required to provide account in relation to estate

2.46 To ensure that persons with a proper interest in the estate (as defined in section 601RAD) are able to access relevant information about the management of the estate, licensed trustee companies need to account to those persons on request.

2.47 On application by a person with a proper interest in an estate that is being administered or managed by the licensed trustee company, the company must provide that person with an account of:

•

the assets and liabilities of the estate;

•

the trustee company's administration or management of the estate;

•

any investment made from the estate;

•

any distribution made from the estate; and

•

any other expenditure (including fees and commissions) from the estate.

[Schedule 2, item 9, subsection 601SBB(1)]

2.48 Failure to provide the account is an offence. The maximum penalty is 50 penalty units. ('Penalty unit' is defined in subsection 4AA(1) of the Crimes Act 1914.) A penalty has been imposed because it is essential that a person with a proper interest is provided with the information contained in properly prepared accounts, so that the person may make an informed assessment about the management of the estate. [Schedule 2, item 28, item 173A in the table]

2.49 If a company has provided an account, and a further account is requested within three months, the company need not provide a further account until that period of three months has expired. A defendant trustee company bears an evidential burden in relation to whether an account has been provided within the three month period, as this is a matter within the knowledge of the company. [Schedule 2, item 9, subsection 601SBB(2)]

2.50 The company may charge a reasonable fee for providing the account under this section. [Schedule 2, item 9, subsection 601SBB(3)]

2.51 If the company fails to account, the Court may, on application by the person, make any order that the Court considers appropriate, including an order requiring the preparation and delivery of proper accounts. [Schedule 2, item 9, subsection 601SBB(4)]

Court may order audit

2.52 This provision enables the Court, on any application under section 601SBB, to order an examination of the accounts of the trustee company relating to the estate by the person named in the order. [Schedule 2, item 9, subsection 601SBC(1)]

2.53 On the making of an order, the trustee company must provide the person with:

•

a list of all the accounts kept by the company relating to the estate; and

•

at all reasonable times, all books (as defined in section 9 of the Corporations Act) in the company's possession relating to the estate; and

•

all necessary information and all other necessary facilities for enabling the person to make the examination.

[Schedule 2, item 9, subsection 601SBC(2)]

2.54 Failure to comply with subsection 601SBC(2) is an offence. The maximum penalty is 50 penalty units. A penalty has been imposed because it is essential that a trustee company comply with a court ordered audit. [Schedule 2, item 28, item 173B in the table]

Division 3 - Common funds

2.55 Division 3 of Part 5D.2 overcomes the rules of trust law that would otherwise prevent the pooling of trust money with other money, or the pooling of money from two or more trusts.

2.56 Trustee companies are permitted to operate common funds to enable the efficient pooling and investment of moneys from different estates. A common fund is a fund that contains money from two or more estates. [Schedule 2, item 9, subsections 601SCA(1) and (2)]

2.57 A common fund can only be established and operated if it contains at least some estate money. If this condition is satisfied, the common fund may also include other money. [Schedule 2, item 9, subsections 601SCA(1) and (3)]

2.58 If investments in common funds are offered to the public, trustee companies must also comply with the managed investment scheme provisions in Chapter 5C of the Corporations Act. These provisions require managed investment schemes to be managed by a responsible entity, which must be a public corporation and hold a dealer's licence. Each scheme must have a constitution, a compliance plan and a registered prospectus.

Obligations relating to common funds

2.59 If a licensed trustee company creates more than one common fund, each common fund must be allocated an appropriate distinguishing number. Failure to do so is an offence, to ensure that persons with a proper interest in an estate can ascertain in which common fund the funds of the estate have been placed. The maximum penalty is 50 penalty units. [Schedule 2, item 9, subsection 601SCB(1); item 28, item 173C in the table]

2.60 The trustee company must keep, for each common fund, accounts showing at all times the current amount for the time being at credit in the fund on the account of each estate. Failure to do so is an offence, to ensure that persons with a proper interest in an estate can ascertain how much money stands to the credit of the estate at any time. The maximum penalty is 50 penalty units. [Schedule 2, item 9, subsection 601SCB(2); item 28, item 173D in the table]

2.61 Estate money cannot be pooled into a common fund if it would be contrary to an express provision of the conditions under which the estate money is held. Failure to comply is an offence, to ensure that the wishes of the person who created the estate are respected. The maximum penalty is 60 penalty units or imprisonment for 12 months, or both. [Schedule 2, item 9, subsection 601SCB(3)]; item 28, item 173E in the table]

Regulations relating to establishment or operation of common funds

2.62 The regulations may include provisions relating to the establishment or operation of common funds. The reason for this broad power is to (for example) enable standards to be set. [Schedule 2, item 9, section 601SCC]

2.63 Regulations made under section 601SCC may alter the effect of section 601SCA, for example, the regulations may limit the circumstances in which other money may be pooled together with estate money. [Schedule 2, item 9, subsection 601SCA(4)]

Part 5D.3 - Regulation of fees charged by licensed trustee companies

2.64 Part 5D.3 of the Schedule regulates the disclosure of fees, and the level of fees, that licensed trustee companies are able to charge their clients for traditional trustee company services.

2.65 The regulation of fees only applies to 'traditional trustee company services'. 'Traditional trustee company services' are defined in section 601RAC. This means that the regulation of fees that occurs under this Part does not apply to fees for any other service that a trustee company may provide, such as acting as a superannuation trustee or being the responsible entity of a managed fund.

2.66 The general approach to the regulation of fees includes:

•

disclosure of fees for all work which may be performed (fees include remuneration/commissions);

•

deregulation of the fees charged to new trusts and estates (other than charitable trusts), subject to a requirement that the company's fee schedule be disclosed on the Internet and a requirement that trustee companies charge no more than the fees specified in their published fee schedule immediately before the trustee company started to provide the service;

•

in relation to charitable trusts:

-

'grandfathering' of fees charged to existing clients ('grandfathering' means that those existing clients will continue to pay the same fees as they did before the new legislation); and

-

capping of fees charged to new clients.

•

The Government is committed to a review of the fee arrangements in relation to charitable trusts after two years of operation.

Division 1 - Disclosure of fees charged to estates and trusts

2.67 Division 1 of Part 5D.3 deals with the disclosure of fees.

Disclosure of fees to the public

2.68 A licensed trustee company must ensure that an up-to-date schedule of its fees that are generally charged for its services (only traditional trustee company services) is:

•

published on a website maintained by or on behalf of the company; and

•

is available free of charge at the trustee company's offices during usual opening hours.

[Schedule 2, item 9, section 601TAA]

2.69 This measure supports the public disclosure of fees which may assist in enhancing transparency of fees and competition among trustee companies. It also provides a measure by which fees are fixed for the duration of the service under section 601TCA. For these reasons, failure to comply is an offence, and the maximum penalty is 60 penalty units or imprisonment for 12 months, or both. [Schedule 2, item 28, item 173F in the table]

Provision of Financial Services Guide

2.70 As part of the requirement for a trustee company to hold an AFSL, licensed trustee companies (and its authorised representatives) must comply with the obligations that attach to the AFSL, including certain disclosure obligations contained in Part 7.7 of the Corporations Act, as modified by regulation, as appropriate. (Under the transitional provisions, this provision does not apply until six months after commencement.) [Schedule 1, item 14, subsection 766A(1A) and (1B)]

2.71 The Schedule amends section 761G to provide that traditional trustee company services are provided to a person as a retail client, subject to a regulation making power primarily designed to deal with unintended consequences and/or obligations that are not relevant to traditional trustee company services. [Schedule 2, items 15 and 16, subsection 761G(6A)]

2.72 Among other obligations, this will mean that a licensed trustee company (or authorised representative) is required to provide a financial services guide (FSG) to its client at the time when the client is seeking to acquire a service (for example, the drafting of a will). This means the client will receive information about the fees in the nature of remuneration (including commissions) that the trustee company charges for traditional trustee company services, as well as other information about the trustee company as set out in subsections 942B(2) and 942C(2). Under section 941D, this disclosure must occur as soon as practicable after it becomes apparent to the trustee company that they will, or are likely, to provide services to the client.

Disclosure to clients of changed fees

2.73 If a licensed trustee company continues to provide traditional trustee company services to a client and the fees that it will charge change, the company must within 21 days of the change in fees taking effect notify the client of the change. The company may:

•

send the client a copy of the changed fee, if the client has made an election under paragraph 601TAB(2) [Schedule 2, item 9, paragraph 601TAB(1)(a)]; or

•

in any other case - directly notify the client, in writing, that the changed fees are available on a website maintained by or on behalf of the company [Schedule 2, item 9, paragraph 601TAB(1)(b)].

2.74 Failure to comply with subsection 601TAB(1) is an offence, to ensure trustee companies provide updated fee schedules to their clients who are affected. The maximum penalty is 60 penalty units or imprisonment for 12 months, or both. [Schedule 2, item 28, item 173G in the table]

2.75 If a client has elected to receive a copy of changes to fees (which is free of charge) they can elect to receive an electronic copy. In any other case, the client must be provided with a hard copy. [Schedule 2, item 9, paragraphs 601TAB(2)(a) and (b)]

2.76 If the client is under a legal disability, a copy of the changed fees, or a notice regarding changed fees, must be provided to the client's agent ('agent' is sufficiently broad to encompass a person's legal representative), and a request referred to in paragraph 601TAB(1)(a) or (2)(a) may be made by the agent.

Division 2 - General arrangements about charging fees

2.77 Division 2 of Part 5D.3 clarifies some matters in relation to arrangements for fees charged to trusts and estates.

Power to charge fees

2.78 This section makes it clear that, notwithstanding any impediment at common law (or in a statute), a licensed trustee company may charge fees for the provision of traditional trustee company services. The power to charge fees is subject to Part 5D.3. [Schedule 2, item 9, subsection 601TBA(1)]

2.79 The section also makes clear that if a provision of Part 5D.3 limits the fees that a trustee company may charge, the trustee company must not charge fees in excess of that limit. Failure to comply with this section is an offence. The maximum penalty is 60 penalty units or imprisonment for 12 months, or both. A penalty has been imposed to ensure that trustee companies adhere to the fee limits. Also, excess fees may be recovered in a civil action under section 601XAA. [Schedule 2, item 9, subsection 601TBA(2); item 28, item 173H in the table and section 601XAA]

2.80 As Division 4 and 5 of this Part place some limits on fees that may be charged, the Schedule clarifies that this Part does not prevent agreements between the parties as to the fees that are charged, either in addition to, or instead of the fees, that are permitted by this Part. This can be a result of:

•

any fees that a testator, in his or her will, has directed to be paid [Schedule 2, item 9, subsection 601TBB(1)]; or

•

any fees that are agreed between the trustee company and a person or persons who have authority to deal with the trustee company on matters relating to the provision of the service (such persons may be prescribed by regulation) [Schedule 2, item 9, subsection 601TBB(2)].

2.81 The legislation clarifies that the Part does not prevent a licensed trustee company from charging a fee permitted by subsection 601SBB(3) for the provision of an account in relation to an estate. [Schedule 2, item 9, section 601TBC]

2.82 The legislation also clarifies that the Part does not prevent the reimbursement of all disbursements properly made by the trustee company in the provision of traditional trustee company services. [Schedule 2, item 9, section 601TBD].

2.83 Finally, where a licensed trustee company provides estate management services, fees charged for the provision of this service must be paid out of the capital or income of the relevant estate. This provision provides flexibility for the licensed trustee company to draw fees from capital or income of the estate, as appropriate. [Schedule 2, item 9, subsection 601TBE(2)]

2.84 This flexibility does not apply to:

•

a management fee (under section 601TDD), which can only come out of income of the relevant estate. This management fee only applies to new charitable trusts; and

•

a common fund administration fee (under section 601TDE or 601TDI), which can only come out of the income received by the common fund. This common fund administration fee only applies to new charitable trusts.

[Schedule 2, item 9, paragraphs 601TBE(3)(a) and (b)]

Division 3 - Fees charged to trusts and estates (other than for being trustee or manager of a charitable trust)

2.85 Division 3 of Part 5D.3 deals with fees charged, other than for charitable trusts.

2.86 A licensed trustee company must not charge fees in excess of its schedule of fees most recently published on its website (required by section 601TAA) before the trustee company started to provide the service. This means that a client cannot be charged more than the fees set out in the schedule of fees for the duration of the service. [Schedule 2, item 9, section 601TCA]

2.87 This fixed fee schedule for the duration of the service provides some certainty to consumers about the level of fees.

2.88 Trustee companies are able to change the schedule of fees as appropriate, reflecting the changing costs of the services, but once the service commences the fees are locked in at the last published schedule of fees.

2.89 As set out earlier, the parties are able to negotiate, either higher or lower fees, than the amount set in the most recent published schedule of fees.

2.90 The fee arrangements (under section 601TCA) do not apply to:

•

the provision of any service that started before commencement of this section; or

•

the service is being the trustee or manager of a charitable trust. Fees for charitable trusts are regulated by Division 4.

Division 4 - Fees for being trustee or manager of a charitable trust

2.91 Division 4 of Part 5D.3 deals with fees in relation to licensed trustee companies providing the service of being the trustee or manager of a charitable trust when the provision of the service started on or after the commencement of section 601TDA. [Schedule 2, section 601TDA]

2.92 Different fee arrangements apply to services provided to new charitable trusts (these being services provided after this section commences), and existing charitable trusts (for services already being provided).

2.93 The Government will review the fees arrangements for both existing and new charitable trusts after the provisions have been in operation for two years.

2.94 The Schedule does not define a 'charitable trust'. The meaning of charitable trust is derived from case law.

Subdivision A - Fees for new charitable trusts

2.95 Subdivision A deals with fee arrangements for new charitable trusts.

2.96 If a licensed trustee company provides traditional trustee company services, being service as the trustee or manager of a charitable trust and that service started on or after the commencement of this section, then, the trustee company must only charge,

•

either:

-

a capital commission and an income commission, as provided under section 601TDC (option 1); or

-

a management fee as provided under section 601TDD (option 2) [Schedule 2, item 9, paragraph 601TDB(1)(a)]; and

•

if applicable, common fund administration fees under section 601TDE [Schedule 2, item 9, paragraph 601TDB(1)(b)]; and

•

if applicable, fees permitted by section 601TDF in respect of the preparation of returns etc [Schedule 2, item 9, paragraph 601TDB(1)(c)].

2.97 This provision mirrors the arrangements set out in Part IV of the Trustee Companies Act 1984 (Victoria).

2.98 As previously outlined, this fee structure does not affect the ability of the charitable trust and the trustee company to negotiate different fee arrangements.

Option 1: Capital and income commission

2.99 The first option is that a trustee company may charge a capital commission and an income commission. [Schedule 2, item 9, section 601TDC]

2.100 The capital commission charged must not exceed 5.5 per cent (goods and services tax (GST) inclusive) of the gross value of the trust assets. 'Gross value of the trust assets' is undefined. The capital commission can only be charged once during the period the trustee company is trustee or manager of the trust. [Schedule 2, item 9, subsections 601TDC(1) and (2)]

2.101 The regulations may make provision relating to the capital commission, which may include (but are not limited to):

•

the calculation of the commission or the gross value of trust assets;

•

when, during the period referred to in subsection (2), the commission may be charged.

[Schedule 2, item 9, subsection 601TDC(3)]

2.102 In addition to the capital commission, the trustee company may charge an annual income commission not exceeding 6.6 per cent (goods and services tax (GST) inclusive) of the income received on trust assets. [Schedule 2, item 9, subsection 601TDC(4)]

2.103 The regulations may make provision relating to the income commission, which may include (but are not limited to):

•

the calculation of the commission or of the income received on the trust assets;

•

when, during the year, the commission may be charged; and

•

apportionment of the amount of the commission for part-years.

[Schedule 2, item 9, subsection 601TDC(5)]

Option 2: Annual management fee

2.104 The second option is that, instead of a capital commission and income commission, a trustee company may charge an annual management fee. The annual management fee must not exceed 1.056 per cent (GST inclusive) of the gross value of the trust assets. (It is understood that the 1.056 per cent figure is based on a monthly figure of 0.08 per cent plus GST.) [Schedule 2, item 9, subsection 601TDD(1)]

2.105 The regulations may make provision relating to the management fee, including (but not limited to):

•

the calculation of the management fee or of the gross value of the trust assets; and

•

when, during a year, the management fee may be charged; and

•

apportionments of the amount of the management fee for part-years.

[Schedule 2, item 9, subsection 601TDD(2)]

Common funds

2.106 If trust assets are included in a common fund operated by the trustee company, the trustee company may charge an annual common fund administration fee not exceeding 1.1 per cent of the gross value of the trust's assets in the fund. [Schedule 2, item 9, subsection 601TDE(1)]

2.107 The regulations may make provisions relating to common fund administration including (but not limited to):

•

the calculation of the common fund administration fee or gross value of the trust assets in the fund; and

•

when, during a year, the common fund administration fee may be charged; and

•

the apportionment of the common fund administration fee for part-years.

[Schedule 2, item 9, subsection 601TDE(2)]

Additional amounts for preparation of returns etc.

2.108 The trustee company may charge a reasonable fee for work involved in the preparation and lodging of returns for the purpose of, or in connection with, assessments of any duties or taxes (other than probate, death, succession or estate duties) related to the trust estate. [Schedule 2, item 9, section 601TDF]

Subdivision B - Existing client charitable trusts

2.109 Subdivision B of Division 4 deals with fee arrangements for existing client charitable trusts. [Schedule 2, item 9, section 601TDG]

2.110 The Schedule 'grandfathers' fees in relation to existing charitable trust clients. 'Grandfathering' generally means that, when rules change, current participants remain unaffected and the new rules only apply to new participants. 'Grandfathering' will apply where the trustee company provides a traditional trustee company service, being a service as the trustee or manager of a charitable trust and that service started before the commencement of this section.

2.111 In those circumstances, the general rule is that the trustee company must not charge fees in excess of fees that it could have charged in relation to the trust immediately before the commencement of this section. [Schedule 2, item 9, section 601TDH]

2.112 However, if any of the trust assets are included in a common fund, the trustee company may charge an annual administration fee not exceeding 1.1 per cent of the gross value of the charitable trust's assets in the fund. This provision enables trustee companies to charge the additional fee at the estate level, rather than at the common fund level. The regulations may make provision for matters relating to the common fund administration fee. [Schedule 2, item 9, section 601TDI]

2.113 Further, the trustee company may charge a reasonable fee for work involved in the preparation and lodging of returns for the purpose of, or in connection with, assessments of any duties or taxes (other than probate, death, succession or estate duties) related to the trust estate. [Schedule 2, item 9, section 601TDJ]

Division 5 - Miscellaneous

2.114 Division 5 deals with miscellaneous matters, including powers of the court regarding excessive fees and directors' fees payable to an officer of a trustee company who acts as director of (another) corporation for purposes connected with the administration or management of an estate.

Power of the Court with respect to excessive fees

2.115 If the Court is of the opinion that the fees charged by a licensed trustee company are excessive in respect of an estate, the Court may review the fees and may, having reviewed the fees, reduce them. [Schedule 2, item 9, subsection 601TEA(1)]

2.116 The Court may not review fees:

•

that are charged as permitted by section 601TBB (that is, fees set by a testator, or agreed between the trustee company and persons with authority to negotiate; or

•

that relate to a charitable trust and are charged in accordance with Subdivision A of Division 4, given that these fees are fixed by law.

[Schedule 2, item 9, subsection 601TEA(2)]

2.117 When the Court is considering whether fees are excessive, the Court may consider any or all of the matters set out in subsection 601TEA(3). Those matters include: the extent to which work performed by the company was reasonably necessary; the period during which the work was, or is likely to be, performed; the complexity (or otherwise) or the work performed, or likely to be performed, by the company; and the extent to which the trustee company was, or is likely to be, required to deal with extraordinary matters. The Court may also consider any other relevant matter. [Schedule 2, item 9, subsection 601TEA(3)]

2.118 The Court may exercise its powers either on its own motion or on application of a person with a proper interest in the estate (as defined in section 601RAD). [Schedule 2, item 9, subsection 601TEA(4)]

2.119 If the Court reduces the fees by more than 10 per cent, the company must, unless the Court in special circumstances otherwise orders, pay the costs of the review. Subject to this proviso, all questions of costs of the review are in the discretion of the Court. [Schedule 2, item 9, subsections 601TEA(5) and (6)]

Directors' fees otherwise payable to an officer of a trustee company

2.120 This provision is intended to apply where an estate being administered or managed by a trustee company has a shareholding or other interest in a corporation, and an officer of the trustee company acts as a director of that corporation for the purposes of administering the estate. [Schedule 2, item 9, subsection 601TEB(1)]

2.121 In such circumstances, the trustee company is entitled to the directors' fees payable to the officer. To clarify matters, neither the officer nor the estate is entitled to such fees. [Schedule 2, item 9, subsections 601TEB(2) and (3)]

Part 5D.4 - Duties of officers and employees of licensed trustee companies

2.122 Part 5D.4 sets out the duties of officers and employees of licensed trustee companies.

2.123 It is the intention of the legislation that State and Territory laws providing for personal liability of directors of trustee companies are to be repealed. In their place, the rules provided by this Schedule, and other Corporations Act provisions, such as section 197, will govern directors and officers' duties and liabilities.

Duties of officers

2.124 An officer of a licensed trustee company has duties imposed under section 601UAA. (These duties are in addition to duties owed under other provisions of the Corporations Act, such as section 197.) In the main, the duties can be classified as:

•

duties of loyalty and good faith; and

•

duties of care, skill and diligence.

[Schedule 2, item 9, section 601UAA]

Duties of loyalty and good faith

2.125 The positive duty of loyalty of an officer of a trustee company is to act honestly. [Schedule 2, item 9, paragraph 601UAA(1)(a)]

2.126 The negative aspects of the duty of loyalty require the officers of trustee companies to avoid the following conflicts of interest:

•

not to make use of information to gain an improper advantage for the officer or another person or cause detriment to the clients of the trustee company; and

•

not to make improper use of their position to gain directly or indirectly an advantage for themselves, or for any other person, or cause detriment to the clients of the trustee company.

[Schedule 2, item 9, paragraphs 601UAA(1)(c) and (d)]

Duties of care, skill and diligence

2.127 An officer of a licensed trustee company must:

•

exercise the degree of care and diligence that a reasonable person would expect if they were in the officer's position [Schedule 2, item 9, paragraph 601UAA(1)(b)]; and

•

take all steps to ensure the trustee company complies with the Corporations Act and its AFSL [Schedule 2, item 9, paragraph 601UAA(1)(e)].

2.128 There are both civil and criminal penalties for a contravention of the duties under subsection 601UAA(1). The intention of the dual regime is to give primacy to the civil penalty regime and retain criminal penalties for serious breaches of the Act.

•

Civil penalties apply for a contravention, or involvement in a contravention, of subsection 601UAA(1). This is reflected in subsection 1317E(1), as amended [Schedule 2, item 9, subsections 601UAA(1); item 27, paragraph 1317E(1)(jaaa)].

•

Also it is an offence to intentionally or recklessly contravene (or be involved in a contravention of) subsection 601UAA(1). The maximum penalty is 300 penalty units or imprisonment for five years, or both [Schedule 2, item 9, subsections 601UAA(1) and (2); item 28, item 173J in the table].

2.129 The duties of an officer of a trustee company under subsection 601UAA(1) override any conflicting duties the officer has under Part 2D.1 of the Corporations Act (duties of officers and employees), but is subject any conflicting duties the officer has under Part 5C.2 (duties of officers and employees of responsible entities of managed investment schemes). [Schedule 2, item 9, subsection 601UAA(3)]

2.130 A reference to a client in this section is a reference to the clients, when viewed as a group (client is defined in subsection 601RAB(3)). [Schedule 2, item 9, subsection 601UAA(4)]

Duties of employees

2.131 The Schedule imposes a negative duty on employees of trustee companies to avoid conflicts of interest. An employee must not:

•

make use of information to gain an improper advantage for the employee or another person or cause detriment to the clients of the trustee company; or

•

make improper use of their position to gain directly or indirectly an advantage for themselves, or for any other person, or cause detriment to the clients of the trustee company.

[Schedule 2, item 9, subsection 601UAB(1)]

2.132 There are both civil and criminal penalties for a contravention of the duties under subsection 601UAB(1). As with subsection 601UAA(1), the intention of the dual regime is to give primacy to the civil penalty regime and retain criminal penalties for serious breaches of the Act.

•

Civil penalties apply for a contravention, or involvement in a contravention of subsection 601UAB(1). This is reflected in subsection 1317E(1), as amended [Schedule 2, item 9, subsection 601UAB(2); item 27, paragraph 1317E(1)(jaab)].

•

Also, it is an offence to intentionally or recklessly contravene (or be involved in a contravention of) subsection 601UAB(1). The maximum penalty is 300 penalty units or imprisonment for five years, or both [Schedule 2, item 9, subsection 601UAB(1); item 28, item 173K in the table].

2.133 The duties of an employee of a trustee company under subsection 601UAB(1) override any conflicting duty the employee has under Part 2D.1 of the Corporations Act (this relates to duties of officers and employees) but is subject any conflicting duties the employee has under Part 5C.2 (duties of officers and employees of responsible entities of managed investment schemes). [Schedule 2, item 9, subsection 601UAB(3)]

2.134 A reference to a client in this section is a reference to the clients, when viewed as a group (client is defined in subsection 601RAB(3)). [Schedule 2, item 9, subsection 601UAB(4)]

Part 5D.5 - Limit on control of licensed trustee companies

2.135 Many State and Territory laws include ownership restrictions for trustee companies. The Schedule also places ownership restrictions on trustee companies. These limitations are intended to maintain a broad spread of ownership and minimise the possibility that a single shareholder could obtain control.

2.136 Part 5D.5 provides for:

•

a prohibition on acquisitions which result in an 'unacceptable control situation'. This has the effect of restricting voting power of any one person (and two or more persons under an arrangement) in a trustee company to 15 per cent, unless the Minister approves a higher shareholding under Division 2 [Schedule 2, item 9, section 601VAA and Division 2 of Part 5D.5];

•

procedures for the Minister to approve a higher shareholding than 15 per cent [Schedule 2, item 9, Division 2 of Part 5D.5];

•

provisions empowering the Court to make a remedial order or issue an injunction where there is an unacceptable control situation [Schedule 2, item 9, sections 601VAC and 601VAD], so long as an order under section 601VAC does not offend paragraph 51(xxxi) of the Constitution relating to unjust acquisition of property [Schedule 2, item 9, section 601VCA]; and

•

an anti-avoidance provision [Schedule 2, item 9, section 601VCC].

2.137 The 15 per cent limitation is comparable to the limitation for 'financial sector companies' under the Financial Sector (Shareholdings) Act 1998. Further, the limitation aligns with Division 1 of Part 7.4 of the Corporations Act on bodies corporate and their holding companies, who hold an Australian market licence or Australian clearing and settlement facility licence.

Unacceptable control situation - the 15 per cent limitation

2.138 An unacceptable control situation exists if a person's voting power in relation to a licensed trustee company exceeds 15 per cent, or exceeds the set percentage in force under Division 2 in relation to that trustee company. [Schedule 2, item 9, section 601VAA]

2.139 It is an offence for a person (or two or more persons) to acquire shares in a body corporate, where the acquisition has the result that:

•

an unacceptable control situation comes into existence in relation to the trustee company; or

•

if an unacceptable control situation already exists in relation to the trustee company - there is an increase in the voting power of the person in the trustee company.

[Schedule 2, item 9, section 601VAB]

2.140 Contravention of section 601VAB is an offence, in order to emphasise the seriousness of a breach of the shareholding limit. The maximum penalty is 120 penalty units or imprisonment for two years, or both. [Schedule 2, item 28, item 173L in the table]

Division 2 - Approval to exceed 15 per cent limitation

2.141 Division 2 empowers the Minister to approve applications to hold more than 15 per cent of the voting power of a licensed trustee company if the Minister is satisfied that it would be in the interests of the licensed trustee company and its clients. This power to increase the 15 per cent ownership limitation is included so that, for example, the range of ownership options in the future is not fettered. For example many trustee companies are wholly-owned subsidiaries of other companies.

2.142 The provisions cover the following:

•

lodging an application with ASIC to exceed the 15 per cent limitation [Schedule 2, item 9, section 601VBA];

•

the Minister granting or refusing such an application [Schedule 2, item 9, section 601VBB] and revoking an approval [Schedule 2, item 9, section 601VBF];

•

the duration of the approval [Schedule 2, item 9, section 601VBC];

•

conditions of approval [Schedule 2, item 9, section 601VBD];

•

varying the percentage approved [Schedule 2, item 9, section 601VBE];

•

seeking further information about an application [Schedule 2, item 9, section 601VBG]; and

•

seeking the views of the licensed trustee company and its clients [Schedule 2, item 9, section 601VBH].

2.143 When the Minister is considering the interests of clients, it is a reference to the interests of the clients, when viewed as a group. [Schedule 2, item 9, section 601VCB]

2.144 The Minister is required to make a decision within 30 days after receiving such an application. However, the Minister may, before the end of 30 days, extend the period in which the decision must be made to 60 days. [Schedule 2, item 9, subsections 601VBI(1) and (2)]

2.145 Time does not run while a request for further information is outstanding (see subsection 601VBG(1)). [Schedule 2, item 9, subsection 601VBI(4]

2.146 However, if the Minister fails to make a decision within the time limit, he or she is taken to have granted what was applied for [Schedule 2, item 9, subsection 601VBI(3)], unless an unacceptable control situation exists [Schedule 2, item 9, subsection 601VBI(5)].

2.147 If a person holds approval under section 601VBB, they must notify ASIC, in writing, if they become aware they have breached a condition to which the approval is subject. [Schedule 2, item 9, subsection 601VBD(8)]

•

Failure to do so is an offence. The maximum penalty is 60 penalty units or imprisonment for 12 months, or both [Schedule 2, item 28, item 173M in the table].

•

Also, the Minister may revoke an approval if the Minister is satisfied that there has been such a contravention of a condition of approval [Schedule 2, item 9, paragraph 601VBF(1)(c)].

Powers of the Court relating to unacceptable control situations

Court orders

2.148 The Court has the power to make orders, as it considers appropriate, for the purposes of remedying an unacceptable control situation. [Schedule 2, item 9, subsection 601VAC(1)]

2.149 The Court's orders may include (but are not limited to), an order:

•

directing the disposal of shares;

•

restraining the exercise of any rights attached to shares;

•

prohibiting or deferring payment of sums due to a person in respect of shares held by the person;

•

that any exercise of rights attached to shares be disregarded;

•

directing any person to do or refrain from doing a specified act, for the purposes of compliance with other orders made; or

•

containing ancillary or consequential provisions as the court thinks just.

[Schedule 2, item 9, subsection 601VAC(3)]

2.150 The Court may only make an order, on application, by specified parties which are:

•

the Minister;

•

ASIC;

•

the trustee company;

•

a person who has voting power in the trustee company; or

•

a client of the trustee company.

[Schedule 2, item 9, subsection 601VAC(2)]

2.151 The court may rescind, vary or discharge an order, or suspend the operation of an order. [Schedule 2, item 9, subsection 601VAC(6)]

Injunctions

2.152 There is a general provision with respect to injunctions in section 1324. The Schedule provides that, if any conduct amounts or would amount to a contravention of Part 5D.5, a trustee company is a person whose interests may be affected, and who thus may apply to the court for an injunction. The class of persons 'whose interests are affected' is not limited by subsection (1). [Schedule 2, item 9, subsections 601VAD(1) and (2)]

2.153 The Minister has the same powers as ASIC to apply for an injunction if the conduct of a trustee company amounts to a contravention of this Part. [Schedule 2, item 9, subsection 601VAD(3)]

2.154 The power to grant remedial orders in section 601VAC and the general injunction power in section 1324 do not, by implication, limit each other. [Schedule 2, item 9, subsection 601VAD(4)]

Other matters

Acquisition of property

2.155 The court must not make a remedial order under section 601VAC if the order would result in the acquisition of property from a person otherwise than on just terms. The court must also not make such an order whereby the order would be invalid because of paragraph 51(xxxi) of the Constitution . Acquisition of property has the same meaning as in paragraph 51(xxxi) of the Constitution, and just terms has the same meaning as in paragraph 51(xxxi) of the Constitution. [Schedule 2, item 9, section 601VCA]

Anti-avoidance

2.156 Section 601VCC outlines the circumstances when the Minister may give the controller a written direction to cease having voting power. A person subject to a written direction must comply with the direction. [Schedule 2, item 9, subsections 601VCC(1) and (2)]

2.157 The section is directed at situations in which a person or persons enter into, begin to carry out or carry out a scheme, for the sole or dominant purpose of avoiding the application of Division 1 of Part 5D.5, and as a result of the scheme, a person (the controller) increases the controller's voting power in a licensed trustee company. 'Scheme' is not defined. [Schedule 2, item 9, subsection 601VCC(1)]

2.158 Failure to comply with a direction is an offence, to prevent avoidance of the application of Division 1 dealing with unacceptable control situations. The maximum penalty is 120 penalty units or imprisonment for two years, or both. [Schedule 2, item 9, subsection 601VCC(2)]

2.159 Subsection (3) states that a direction under subsection (1) 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 (Legislative Instruments Act) on general principles. [Schedule 2, item 9, subsection 601VCC(3)]

2.160 For the purposes of this section , increase voting power includes increasing it from a starting point of nil. [Schedule 2, item 9, subsection 601VCC(4)]

Part 5D.6 - Consequences of cancellation of Australian financial services licence

2.161 Because a trustee company requires an AFSL to provide traditional trustee company services, if ASIC cancels its AFSL, the company can no longer provide the services, potentially leaving clients without an entity to manage or administer estates in which they have an interest. (This is subject to section 915H, which provides that when ASIC suspends or cancels an AFSL, ASIC may specify that the licence continues in effect for the purposes of specified provisions of the Corporations Act in relation to specified matters, a specified period, or both.)

2.162 Part 5D.6 deals with this situation by providing for the transfer of estate assets and liabilities from the former licensed trustee company to another licensed trustee company, if certain conditions are satisfied.

2.163 Broadly, there is a two-stage process in which:

•

ASIC makes a compulsory transfer determination, if specified conditions are satisfied. This means there is to be a transfer of estate assets and liabilities to a new licensed trustee company (the receiving company);

•

Second, ASIC issues a certificate of transfer, to effect the transfer of estate assets and liabilities to the receiving company, if specified conditions are satisfied.

Key definitions for the Part

2.164 Subsection 601WAA(1) defines several key terms for the purposes of this Part dealing with the consequences of cancellation of an AFSL.

•

asset includes, in general terms, any legal or equitable estate or interest in real or personal property, whether present or future, vested or contingent, tangible or intangible. It also covers any chose in action; any right, interest or claim of any kind; and any capital gains tax (CGT) asset [Schedule 2, item 9, subsection 601WAA(1)];

•

cancel in relation to a licence means the cancellation of a licence under Part 7.6 or a variation of the licence so that it ceases to cover traditional trustee company services [Schedule 2, item 9, subsection 601WAA(1)];

•

estate assets and liabilities means assets (including assets in common funds) and liabilities:

-

of an estate, in relation to which the trustee company (before its licence was cancelled) was performing estate management functions; and

-

that, immediately before the cancellation, were vested in the trustee company because it was performing those functions, or were otherwise assets and liabilities of the trustee company because of its performance of those functions [Schedule 2, item 9, subsection 601WAA(1)];

•

liability includes a duty or obligation of any kind, whether arising under an instrument or otherwise, and whether actual, contingent or prospective [Schedule 2, item 9, subsection 601WAA(1)].

2.165 The subsection also defines authorised ASIC officer, interest and licence.

2.166 ASIC may, in writing, authorise a person (who is a member of ASIC or its staff) to perform or exercise functions of powers under this Part. [Schedule 2, item 9, subsection 601WAA(2) and definition of authorised ASIC officer in section 601WAA]

Compulsory transfer determinations

2.167 If ASIC cancels the licence of a trustee company, ASIC, may, in writing, make a determination (which is a compulsory transfer determination) that there is to be a transfer of the estate assets and liabilities from the transferring company to another licensed trustee company (the receiving company).

2.168 ASIC can only make a compulsory transfer determination if:

•

either:

-

the Minister has consented to the transfer; or

-

the Minister's consent is not required [Schedule 2, item 9, paragraph 601WBA(2)(a)]; and

•

ASIC is satisfied that:

-

the transfer is in the interests of the clients of the transferring company (when viewed as a group) and clients of the receiving company (when viewed as a group). (Client is defined in subsection 601RAB(3) to only include a client being provided with traditional trustee company services) [Schedule 2, item 9, paragraph 601WBA(2)(a)]. (The Minister or ASIC may seek the views of the licensed trustee company and its clients, as part of the possible exercise of their powers.) [Schedule 2, item 9, section 601WCH];

•

the board of the receiving company has consented to the transfer. This consent is in force until it is withdraw by the board with the agreement of ASIC. ASIC may agree to allow the board to withdraw its consent, such as where circumstances have arisen since consent was given or taking into account other relevant matter [Schedule 2, item 9, section 601WBB];

•

State and Territory legislation (that satisfies section 601WBA) to facilitate the transfer has been enacted in the State or Territory [Schedule 2, item 9, paragraph 601WBA(2(b)(iv) and section 601WBC].

2.169 The determination must include particulars of the transfer, including the names of the transferring and receiving company and the extent of transfer of the estate assets and liabilities. The determination must also include a statement of reasons why the determination has been made. [Schedule 2, item 9, subsections 601WBA(3) and (4)]

2.170 Subsection (5) states that the determination 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 on general principles. [Schedule 2, item 9, subsection 601WBA(5)]

Minister's power to decide that consent not required

2.171 Under section 601WBD, the Minister's consent is not required if the Minister has determined in writing that his or her consent is not required in relation to the transfer or a class of transfers. The regulations may prescribe criteria to be taken into account by the Minister in deciding whether to make a determination. [Schedule 2, item 9, subsections 601WBD(1) and (2)]

2.172 Subsections (3) and (4) clarify when a determination is, or is not, a legislative instrument. These provisions are included to assist readers, as a single transfer determination is not a legislative instrument within the meaning of section 5 of the Legislative Instruments Act on general principles. [Schedule 2, item 9, subsections 601WBD(3) and (4)]

Determinations may impose conditions

2.173 The determination may impose conditions on the receiving or transferring company, either or both, before or after the certificate of transfer has been issued. [Schedule 2, item 9, subsection 601WBE(1)]

2.174 ASIC may vary or revoke determinations if it considers it appropriate. The transferring or receiving company may also apply to ASIC for variation or revocation for conditions imposed under paragraph 601WBE(1)(b), that is, after the certificate of transfer has been issued. ASIC must notify the relevant company of its action or decision in writing. [Schedule 2, item 9, subsections 601WBE(2) and (3)]

2.175 It is an offence for the transferring or receiving company not to comply with conditions imposed by ASIC, to ensure compliance with this provision. The maximum penalty is 50 penalty units. [Schedule 2, item 9, subsection 601WBE(5); item 28, item 173P in the table]

2.176 Subsection 601WBE(6) specifies that a transferring company or a receiving company does not commit an offence against the Corporations Act merely because the company is complying with a condition imposed by ASIC. A defendant bears the evidential proof in relation to the defence under subsection 601WBE(6), as these are matters squarely within the knowledge of the defendant. [Schedule 2, item 9, subsection 601WBE(6)]

Notice of determination

2.177 ASIC must give a copy of the determination to the transferring and receiving company. [Schedule 2, item 9, section 601WBF]

Certificate of transfer

2.178 If ASIC has made a compulsory transfer determination, and ASIC considers that the transfer should go ahead and consent of the board under subparagraph 601WBA(2)(b)(iii) has not been withdrawn, ASIC must issue, in writing, a certificate (known as a certificate of transfer) that the transfer is to take effect. [Schedule 2, item 9, subsection 601WBG(1)]

2.179 The certificate of transfer must include the names of the transferring and receiving company, the details of the extent of transfer of estate assets and liabilities, and when the certificate is to come into force [Schedule 2, item 9, subsection 601WBG(2)]. The certificate comes into effect in accordance with the statement in the certificate [Schedule 2, item 9, subsection 601WBG(4)].

2.180 The certificate may include provisions specifying, or specifying a mechanism for determining, other things that are to happen, or that are taken to be the case, in relation to the assets and liabilities subject to the transfer. [Schedule 2, item 9, subsection 601WBG(3)]

2.181 Subsection (5) clarifies that the certificate 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 on general principles. [Schedule 2, item 9, subsection 601WBG(5)]

Notice of certificate

2.182 ASIC must give a copy of the certificate of transfer to the transferring and receiving company, and must publish notice of the issue of the certificate (publish means in accordance with the regulations: see section 601RAA). [Schedule 2, item 9, section 601WBH]

Time and effect of compulsory transfer

2.183 The effect of a certificate coming into force is that the receiving company becomes the successor in law of the transferring company in relation to the estate assets and liabilities, to the extent of the transfer. If the certificate includes provisions of a kind specified in subsection 601WBG(3) (that is, provisions that specify other things that are to happen, or that are taken to be the case), those things are taken to happen, or to be the case. [Schedule 2, item 9, section 601WBI]

Substitution of trustee company

2.184 Further, the receiving company is substituted for any appointment or nomination (for example as trustee, executor or administrator) of the transferring company in relation to estate assets and liabilities. [Schedule 2, item 9, section 601WBJ]

Liabilities for breach of trust and other matters

2.185 This Part does not apply to or affect liabilities of the transferring company for:

•

any breach of trust;

•

any other misfeasance or nonfeasance; or

•

any exercise of, or failure to exercise, any discretion.

[Schedule 2, item 9, subsection 601WBK(1)]

2.186 This Part does not affect any rights of the transferring company, or of an officer or employee of the transferring company, to indemnity in respect of such liabilities. [Schedule 2, item 9, subsection 601WBK(2)]

Other matters related to transfer of estate assets and liabilities

2.187 Division 3 deals with various other matters in relation to the transfer of estate assets and liabilities, including:

•

an authorised ASIC officer may certify that a specified asset or liability becomes an asset or liability of the receiving body [Schedule 2, item 9, section 601WCA];

•

enabling certificates in relation to land, interests in land and other assets to be dealt with, and given effect to, in certain circumstances [Schedule 2, item 9, sections 601WCB and 601WCC];

•

documents purporting to be a certificate under this Division is taken to be such a certificate, unless the contrary is established [Schedule 2, item 9, section 601WCD];

•

from when a certificate of transfer comes into force, a reference to a transferring company in relation to assets and liabilities transferred under this Part, is taken to be a reference to the receiving company [Schedule 2, item 9, section 601WCE];

•

the transferring company must promptly account to the receiving company for any income or other distribution received if the income or distribution arises from assets transferred under this Part - consistently with other provisions in the Corporations Act, failure to comply is an offence [Schedule 2, item 9, section 601WCF; item 28, item 173Q in the table];

•

the transferring company must, at the request of the receiving company, give the receiving company access to all of the books in its possession that relate to assets or liabilities transferred under this Part . Books is defined in existing section 9 of the Corporations Act. Consistently with other provisions in the Corporations Act, failure to comply is an offence [Schedule 2, item 9, section 601WCG; item 28, item 173R in the table]; and

•

for the purpose of deciding whether to exercise powers under this Part, the Minister or ASIC may seek the views of a trustee company or its clients [Schedule 2, item 9, section 601WCH].

Miscellaneous

2.188 Division 4 of Part 5D.6 deals with miscellaneous provisions.

2.189 Section 601WDA includes the obligation of the transferring company to notify persons of the cancellation of its licence and the transfer of estate assets and liabilities to the receiving company. This is to ensure that, as far as possible, persons affected by the cessation of the trustee company's business have notice of it.

2.190 The trustee company (when its licence is cancelled) must, as soon as practicable, take all reasonable steps to contact the following persons, and advise them of the cancellation of the licence:

•

all persons who have executed and lodged, such as wills, that have not yet come into effect, but will potentially lead to estate assets and liabilities being held by the trustee company;

•

all persons who have appointed the trustee company as trustee or to some other capacity.

[Schedule 2, item 9, subsection 601WDA(1)]

2.191 The trustee company must also publish notice of the cancellation of the licence. [Schedule 2, item 9, paragraph 601WDA(1)(b)]

2.192 Further, if a certificate of transfer comes into force, the trustee company must, as soon as practicable, take all reasonable steps to contact the persons referred to above and advise them of the transfer of estate assets and liabilities to the receiving company. [Schedule 2, item 9, subsection 601WDA(2)]

2.193 Failure to comply with subsections 601WDA(1) and (2) is an offence, to ensure that the obligation to notify interested persons is upheld. The maximum penalty is 120 penalty units or imprisonment for two years, or both.

Part 5D.7 - Effect of contraventions

Civil liability of licensed trustee company

2.194 Section 601XAA provides that a person who has suffered loss or damage because of the conduct of a licensed trustee company that contravenes Chapter 5D may take proceedings against the trustee company to recover the loss or damage. There is a limitation period of six years on bringing actions. [Schedule 2, item 9, subsections 601XAA(1) and 601XAA(3)]

2.195 Subsection (2) clarifies that charging a person an excess fee (which is paid by the person) gives rise to a loss that is recoverable under subsection (1). [Schedule 2, item 9, subsection 601XAA(2)]

2.196 The section does not affect any liability under other provisions of the Corporations Act or other laws. [Schedule 2, item 9, subsection 601XAA(4)]

Part 5D.8 - Exemptions and modifications

2.197 It is considered appropriate to include exemption and modification powers, for example, to reflect subsequent changes in the charging and disclosure of fees, or changes in State and Territory laws and procedures concerning administration of estates and the powers of courts.

ASIC exemption and modification power

2.198 ASIC has the power to make exemptions or modifications to Chapter 5D. This is considered necessary to ensure the provisions can apply with appropriate flexibility (for example, ASIC can issue class order relief where necessary). ASIC may:

•

exempt a person or class of persons, or an estate or class of estates, from all or specified provisions of this chapter; or

•

declare that this chapter applies to a person or class of persons, or an estate or class of estates, as if specified provisions were omitted, modified or varied as specified in the declaration.

[Schedule 2, item 9, subsection 601YAA(1)]

2.199 An exemption may apply unconditionally or subject to specified conditions. A person must comply with a condition specified in the exemption and the Court may order a person to comply. Only ASIC may apply to the Court for such an order. [Schedule 2, item 9, subsection 601YAA(2)]

2.200 An exemption or declaration is a legislative instrument if it expressed to apply to a class of persons or a class of estates [Schedule 2, item 9, subsection 601YAA(3)]. If this does not apply, ASIC must publish notice of the exemption or declaration in the Gazette. The exemption or determination is not a legislative instrument. The statement at the end of subsection (4) is included to assist readers, as a single person exemption or declaration is not a legislative instrument within the meaning of section 5 of the Legislative Instruments Act on general principles [Schedule 2, item 9, subsections 601YAA(4)].

2.201 The provisions contain a requirement that ASIC must notify a person in writing about a declaration or make it available on the Internet before such a declaration can result in the person having any additional criminal liability. Generally, exemptions are not subject to the same notice requirements, as contraventions of exemptions do not give rise to any additional criminal liability. These provisions will ensure that people cannot potentially be subject to criminal liability for failing to comply with requirements about which they could not have been aware. [Schedule 2, item 9, subsection 601YAA(5)]

2.202 Subsection (6) defines the meaning of provisions of this chapter for the purposes of section 601YAA. [Schedule 2, item 9, subsection 601YAA(6)]

Exemptions and modifications by regulations

2.203 The regulations may also:

•

exempt a person or class of persons from all or specified provisions of this chapter; or

•

declare that this chapter applies to a person or class of persons as if specified provisions were omitted, modified or varied as specified in the declaration.

[Schedule 2, item 9, subsection 601YAB(1)]

2.204 These powers are considered necessary as there may be certain situations that may give rise to a need to modify a provision of new Chapter 5D, or to exempt a person from a provision of Chapter 5D. For example, it may be appropriate to exempt persons from, or modify the effect of, the fee charging provisions. Also, it may be desirable to modify the duties of officers and employees of licensed trustee companies.

2.205 Subsection (2) defines the meaning of provisions of this chapter for the purposes of section 601YAB. [Schedule 2, item 9, subsection 601YAB(2)]

Regulating traditional trustee company services as financial services under Chapter 7 of the Corporations Act

2.206 Amendments are made to Chapter 7 to regulate traditional trustee company services under Chapter 7, as appropriate. In particular, the licensing and general conduct obligations will apply to trustee companies. Certain disclosure obligations may also apply, notably the obligation to provide retail clients of trustee companies with a Financial Services Guide. The detailed application of these rules will be set out in regulations.

Traditional trustee company services are generally provided to retail clients

2.207 An amendment is made to the definition of a retail client in existing section 761G to provide that traditional trustee company services are always provided to persons as retail clients, unless the regulations otherwise provide. Many obligations in Chapter 7 only apply where a product or service is provided to a retail client, for example, an FSG must only be supplied where a financial service is provided to a retail client. Regulations enable this provision to be modified as appropriate. [Schedule 2, items 15 and 16, subsection 761G(6A)]

2.208 This provision provides flexibility to make special provisions about whether a client of a trustee company is a retail or wholesale client. This then determines for example who should receive the disclosure prescribed by Chapter 7. Classification as a retail or wholesale client determines whether certain obligations under Chapter 7 apply or not. For example, provision of a Financial Services Guide is dependent on the client being a retail client: section 941A.

2.209 A related amendment is also made to subsections 761G(7) and 761GA to provide that a person is not considered to be a wholesale client in specified circumstances. [Schedule 2, items 17 and 18, subsection 761G(7) and section 761GA]

Traditional trustee company services provided by trustee companies are financial services

2.210 Amendments to existing subsection 766A(1) provide that the provision of a traditional trustee company service by a trustee company is taken to be the provision of a financial service. This means the trustee company will need an AFSL to provide traditional trustee company services, as a person who carries on a financial services business must be licensed to provide that service. [Schedule 2, item 19, subsection 766A(1A)]

2.211 The regulations may, in relation to a traditional trustee company service of a particular class, prescribe the person or persons to whom a service of that class is taken to be provided. [Schedule 2, item 19, subsection 766A(1B)]

2.212 A further change is made to existing subsection 911A(4) to ensure that persons who provide traditional trustee company services are not exempt from the need to hold an AFSL due to subsection 991A(2) (which provides a list of persons that are exempt from the requirement to obtain an AFSL). [Schedule 2, item 20, subsection 911A(4)]

2.213 Subsection 915B(3) gives ASIC powers to suspend or cancel an AFSL of a body corporate if certain things happen. An amendment is made to the effect that ASIC may cancel or suspend the AFSL of a trustee company if its clients have suffered or are likely to suffer losses because the company has breached the Corporations Act or the financial services law as defined. This gives ASIC powers to proceed against a licensed trustee company engaging in inappropriate conduct where it considers that the conduct is of a sufficiently serious nature to warrant such proceedings. [Schedule 2, item 24, paragraph 915B(3)(ca)]

2.214 Amendments are made to section 912D to ensure that an AFSL providing traditional trustee company services must notify ASIC of breaches or likely breaches, relating to non-compliance with financial services law, which for this purpose includes a breach of Commonwealth, State or Territory legislation, or a rule of common law or equity. [Schedule 2, items 21 to 23, subparagraphs 912D(1)(a)(iii) and 912D(1)(a)(iv)]

2.215 Amendments are made to the definition of financial services law in existing section 761A, so that it includes new Chapter 5D and also includes any rule of common law or equity covering conduct by an AFSL relating to traditional trustee company services. [Schedule 2, items 10 and 11, section 761A and paragraph 761A(e)]

Other amendments

Application of Chapter 5D to the Crown

2.216 Section 5A deals with the application of the Corporations Act to the Crown. Schedule 2 amends subsection 5A(4) to provide that a provision of new Chapter 5D only binds the Crown in a particular capacity in circumstances (if any) specified in the regulations. "Crown" includes the Crown in right of the Commonwealth, a State, or the Northern Territory or the Australian Capital Territory. This is to ensure that, for example, a public trust office of a State or Territory could be covered by Chapter 5D (if the relevant State or Territory agreed). [Schedule 2, item 4, subsection 5A(4)]

Court order required before trustee company can be voluntarily wound up if estates remain unadministered

2.217 Schedule 2 amends section 490 of the Corporations Act to provide that, if a trustee company wishes to be voluntarily wound up, and any estates under its control remain unadministered, the company must obtain a court order. A person with a proper interest in the estate is entitled to be heard in any proceedings for leave to voluntarily wind up the company. This provision does not extend to voluntary administration. [Schedule 2, items 3 and 4, subsection 490(1), paragraph 490(1)(c) and subsection 490(2)]

Dealing with clients' money

2.218 Division 2 of Part 7.8 makes provision for dealing with clients' money. Amendments to subsection 981A(2) provide that Division 2 does not regulate clients' money paid for the provision of traditional trustee company services provided by the trustee company. This means that the rules of Chapter 5D, and any preserved rules under State or Territory law, will apply to clients' money. [Schedule 2, item 25, paragraph 981A(2)(ca)]

Civil and criminal penalties

2.219 Subsection 1311(1A) of the Corporations Act states that the general penalty provisions of the Act only apply to a provision if a penalty is set out in Schedule 3 to the Act for that provision. Schedule 2, item 26 adds Chapter 5D to that list. [Schedule 2, item 26, paragraph 1311(1A)(daa)]

2.220 Subsection 1317E(1) of the Corporations Act lists a number of provisions in respect of which, if the Court is satisfied that a person has contravened the provision, it must make a declaration of (civil) contravention. Schedule 2, item 23 adds the duties of officers and employees of trustee companies to that list. [Schedule 2, item 27, paragraph 1317(1)(jaaa) and (jab)]

Consequential amendments of Corporations Act and other Acts

Corporations Act amendments

2.221 Consequential changes are made to insert definitions of licensed trustee company, traditional trustee company services and trustee company in existing section 761A (existing definitions for Chapter 7). These definitions have the same meaning as set out in Chapter 5D. [Schedule 2, items 12 to 14, section 761A]

2.222 Chapter 2L of the Corporations Act regulates debentures. Section 283AC sets out the entities, including trustee companies (paragraph (1)(b)), that can be appointed as trustees of debenture issues. The Schedule amends paragraph 1(b) to update the definition of 'licensed trustee company' for the purposes of this provision. [Schedule 2, item 6, paragraph 283AC(1)(aa)]

2.223 The general penalty provisions (section 1311) are amended to ensure that subsection 1311(1), the 'default' offence provision of the Corporations Act, only applies to a provision in Chapter 5D if a penalty is set out in Schedule 3 to the Corporations Act. [Schedule 2, item 26, paragraph 1311(1A)(daa)]

2.224 Section 1317E of Part 9.4 (Civil consequences of contravening civil penalty provisions) is amended to provide that if a court is satisfied that either of subsection 601UAA(2) or 601UAB(2) (duties of officers or employees of licensed trustee companies) is contravened, the Court must make a declaration of contravention. [Schedule 2, item 27, paragraphs 1317E(1)(jaaa) and (jaab)]

ASIC Act amendments

2.225 Amendments are made to ensure that the ASIC Act contains similar powers and functions, in relation to licensed trustee companies and traditional trustee company services, to those that are being inserted into the Corporations Act (in new Chapter 5D and Chapter 7).

2.226 Accordingly, the interpretation provision of the ASIC Act, subsection 12BA(1), is amended to include definitions of traditional trustee company services and trustee company. [Schedule 2, items 1 and 2, subsection 12BA(1)]

2.227 Also, the meaning of financial service in section 12BAB is amended to ensure that it includes the provision by a trustee company of a traditional trustee company service. The regulations may, in relation to a traditional trustee company service of particular class, prescribe the person or persons to whom a service of that class is taken to be provided or supplied. [Schedule 2, item 3, subsections 12BAB(1A) and (1B)]

Commencement and transitional provisions

2.228 Schedule 2 to the proposed Schedule dealing with trustee companies commences on a single day to be fixed by proclamation. However, if any of the provisions do not commence within six months from the day the Bill receives Royal Assent, they commence on the first day after the end of that period. [Schedule 2, item 2, item 3 in the table]

2.229 The delay in commencement, but for no longer than six months, allows the States and Territory Governments to amend their laws, so they are consistent with the Commonwealth regime.

2.230 Schedule 5, the transitional provisions, commences on Royal Assent. However, the operation of the transitional provisions is tied to the commencement of Schedule 2.

2.231 Transitional provisions are made to ensure that existing trustee companies are able to continue providing their services to clients before they are issued with an AFSL authorising them to provide traditional trustee company services. Without these provisions, these services would have to be interrupted when the new Commonwealth legislation took effect, and could only be resumed once the AFSL was issued.

2.232 To enable the transitional provisions to operate, Division 2 of Schedule 5 creates definitions of 'amending Schedule', 'commencement' and 'modify'. [Schedule 2, section 1493]

Transitional provisions relating to limit on control of trustee companies

2.233 Substantively, in relation to Part 5D.5 (limit on control of trustee companies) the transitional provisions provide relief for existing authorised trustee companies where a person's voting power already exceeds 15 per cent. The provision, in effect, permits the person to retain their pre-commencement percentage. Where a person subsequently exceeds their pre-commencement percentage, the normal rules of Part 5D.5 apply. There are special rules where a person's percentage is subsequently reduced. [Schedule 2, section 1494]

Transitional provisions relating to the amendments of Chapter 7

2.234 A trustee company that is listed in the regulations under section 601RAB, and that, at that time, already holds an AFSL, is taken to be authorised under its AFSL to provide traditional trustee company services for a period of six months starting on the date of commencement of the regulations providing the list of trustee companies. [Schedule 2, paragraph 1495(2)(a)]

2.235 The provisions regarding the disclosure to clients of changed fees (see section 601TAB) also do not apply during this period. However, this does not extend to the requirement that the trustee company must disclose its current schedule of fees on a website maintained by or on behalf of the company (section 601TAA). [Schedule 2, paragraph 1495(2)(b)]

2.236 It is also provided that the requirements in Part 7.7 of the Corporations Act do not apply during this period. Part 7.7 contains provisions relating to the FSG and statements of advice. At the end of the six month period, a trustee company can only provide traditional trustee company services if it has obtained an AFSL. [Schedule 2, paragraph 1495(2)(c)]

2.237 To avoid doubt, ASIC powers under Part 7.6 (licensing of financial service providers) are not limited in relation to the company's AFSL. [Schedule 2, subsection 1495(3)]

Example 2.2

For example, during the six month period, ASIC may impose or vary licence conditions in relation to the deemed licence.

General power for regulations to deal with transitional matters

2.238 There is a regulation power to deal with transitional matters and it may for those purposes modify this Bill. This is designed to ensure that there is a smooth transition from State and Territory regulation to Commonwealth regulation. [Schedule 2, section 1496]

Chapter 3 - Regulation of debentures

Outline of chapter

3.1 Schedule 3, item 1 to the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 (Bill) amends the Corporations Act 2001 (Corporations Act) so that promissory notes valued at $50,000 or over come under the same regulatory regime as debentures.

3.2 Schedule 3, item 2 to the Bill amends the Corporations Act to require the establishment of a publicly available register of debenture trustees.

3.3 The key measures relating to the register are that:

•

the Australian Securities and Investments Commission (ASIC) is required to establish and maintain a register relating to trustees for debenture holders;

•

borrowers are obliged to provide information for the purposes of the register and would be guilty of an offence for failure to do so; and

•

persons have the right to inspect the register and make copies, or extract parts of the information, for which a fee may apply.

Context of amendments

3.4 In June 2008 the Government released the Green Paper Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Regulation which canvassed a number of possible reforms in the financial services sector, including in relation to debentures regulation.

3.5 The Corporations Act, principally Chapter 2L, sets out the regulatory environment for the issue of debentures. Debentures are debt instruments used by the issuer (or borrower) to raise funds from investors in return for the payment of interest. Debenture issues are governed by a trust deed and a requirement for the appointment of a trustee, who undertakes a range of investor protection functions on behalf of debenture holders.

3.6 Following a number of corporate collapses, in particular, the Westpoint group, the Government undertook a review of the debentures regulatory regime, with the aim of improving protection for retail investors.

3.7 In particular, concerns were raised about unlisted debentures, as they pose a greater risk to retail investors in that they do not have a ready market, nor the same level of public scrutiny of the ongoing performance of the issuer as is available for listed debentures.

3.8 To assist investors in better understanding the nature and risks of investing in debentures, ASIC has issued guidelines aimed at improving disclosure requirements for borrowers and others involved in the issue of unlisted and unrated debentures (Regulatory Guides (RG) 169 and 156). The guidelines address some of the key risk areas for consumers.

3.9 One of the main issues arising from the Westpoint case is the inconsistent regulation of promissory notes and debentures. Promissory notes are a form of debenture whereby borrowers raise funds from investors and promise repayment at a future point in time. However, within the promissory note regulatory regime, different regulation applies depending on the value of the note:

•

if the promissory note is valued at less than $50,000, it is regulated as a debenture;

•

if it has a face value of at least $50,000, the note is regulated as a financial product.

3.10 This inconsistency produced the uncertainty in the Westpoint case. Westpoint tried to avoid the operation of the law relating to debentures by issuing promissory notes with face values of at least $50,000. Because of the uncertainty regarding their regulatory treatment at that time, court action by ASIC was necessary to confirm that the promissory notes on issue were subject to the operation of the Corporations Act (in this case, it was determined that the issue took the form of an interest in a managed investment scheme).

3.11 Investors in Westpoint and other companies which also issued debentures, such as the Fincorp group and Australian Capital Reserve Limited, lost considerable amounts of money. While there are a range of reasons for these losses apart from the regulatory regime, the amendments provide improved clarity and consistency in the law.

3.12 The amendments also provide for the establishment of a register of debenture trustees.

3.13 Under the Corporations Act, the issue or offer of debentures requires that the body which makes the offer or issue (the borrower) must, inter alia, enter into a trust deed and appoint a trustee.

3.14 The role of the trustee is to provide a level of investor protection for debenture holders. Only certain entities are permitted to undertake this role, as set out in Chapter 2L of the Corporations Act. Trustees' duties include those set out in the Corporations Act, as well as those in ASIC's guidelines on debentures (RG 69 and 156). The guidelines emphasise the need for trustees to actively monitor the financial position and performance of the debenture issuer.

3.15 The amendments enhance transparency by providing for public access to the list of trustees, who are required under law to represent the interests of investors and undertake important responsibilities on their behalf.

Summary of new law

3.16 Under the amendment to the definition of debentures in the Corporations Act, promissory notes valued at $50,000 and over fall under the definition of 'debenture' and are therefore subject to the same regulatory regime as debentures.

3.17 This Bill also amends the Corporations Act to require ASIC to establish a publicly available register relating to trustees for debenture holders and to maintain it. Regulations may prescribe the way in which the register must be established or maintained and the information ASIC must include in the register. The amendments also require borrowers to provide ASIC with relevant information in relation to the trustee, including for the purposes of establishing and maintaining the register.

Comparison of key features of new law and current law

Detailed explanation of new law

Definition of debenture

3.18 Section 9 of the Corporations Act defines a 'debenture' and specifies exclusions. The amendment removes the exemption that a debenture does not include 'an undertaking to pay money under a promissory note that has a face value of at least $50,000'. [Schedule 3, item 1, section 9, paragraph (d), of definition of debenture]

3.19 With the removal of paragraph (d), all promissory notes, regardless of value, are treated as debentures. As such, promissory notes valued at $50,000 or over issued after commencement are subject to the same regulatory requirements as debentures including, inter alia, the issue of a trust deed, the appointment of a trustee and the issue of a prospectus.

3.20 The amendment removes the inconsistency between the regulation of promissory notes and debentures and avoids further uncertainty in the operation of the law.

Duty to notify ASIC of information related to the trustee

3.21 Under current law, the Corporations Act requires debenture issuers or borrowers to undertake a number of duties, including notifying ASIC of the name of the trustee within 14 days of appointment. Failure to comply is an offence under section 283BI of the Corporations Act. Under this requirement, borrowers lodge the required information through the prescribed form (known as Form 722).

3.22 Under the amendments, borrowers of new issues will be required to provide ASIC, for the purposes of the register and in the prescribed form, the name of the trustee, as well as any other information related to the trustee or the debentures, as prescribed by the regulations. It is expected that ASIC will utilise an amended version of the existing Form 722 for this purpose. [Schedule 3, item 2, section 283BC]

3.23 The information must be provided to ASIC within 14 days of the appointment of the trustee, or within the same period following any changes to the information, as applicable. Failure to provide the information is subject to the existing offence provision (section 283BI), which may lead to a 25 unit penalty (equivalent to $2,750) or imprisonment, or both.

Register relating to trustees for debenture holders

3.24 Under new section 283BCA, ASIC is required to establish and maintain a register relating to trustees for debentures holders. Details of the information to be included in the register are to be set out in the regulations. This provides flexibility to amend the requirements or obtain other information, if required, in the future. [Schedule 3, item 3, section 283BCA]

3.25 The required information is likely to be:

•

name and address of the borrowing company;

•

name and address of the trustee;

•

name of the trust to which it has been appointed;

•

the trustee's Australian company number or Australian Business Number; and

•

date of the trust deed.

3.26 The amendments also provide scope for the regulations to prescribe the way in which the register must be established and maintained. It is expected that ASIC will manage this process as part of its regulatory activities and generally without unnecessary prescription.

3.27 The amendments also provide for the register to be available for inspection, to be copied, or extracts taken from it. Inspection of the register may incur a fee (as prescribed under the regulations). As with other registers, it is expected that online access would be free, although charges may apply to attend in person.

Application and transitional provisions

3.28 The amendment relating to promissory notes commences on Royal Assent and applies to promissory notes issued after commencement. Earlier issues are subject to the appropriate law at the time of issue. [Schedule 5, section 1498]

3.29 The register provisions commence on Proclamation to allow time for ASIC to establish the necessary processes and systems to create the register. The amendments apply to trustees appointed on or after commencement. [Schedule 5, section 1498]

Chapter 4 - Technical amendment relating to jurisdiction of courts

Outline of chapter

4.1 Schedule 4 to the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 amends the Corporations Act 2001 (Corporations Act) to correct a technical error in Chapter 9, subsection 1338B(8).

Context of amendments

4.2 Chapter 9, Part 9.6A, Division 2 of the Corporations Act deals with the jurisdiction of courts in relation to criminal matters. Subsection 1338B provides that State and Territory courts have equivalent jurisdiction with respect to certain offences. The amendment corrects an omission in paragraph (8) to include a court of 'the Capital Territory'.

Summary of new law

4.3 The amendment corrects an omission so that the courts of all Australian States and Territories are included within the provision.

Comparison of key features of new law and current law

Detailed explanation of new law

4.4 Schedule 4, item 1 is a technical amendment only and inserts a reference to a court of the Capital Territory, which had been incorrectly omitted. [Schedule 4, item 1, subsection 1338B(8)]

Application and transitional provisions

4.5 The amendment commences on the day on which this Bill receives Royal Assent.

Chapter 5 - Regulation impact statement - Margin loans

Commonwealth regulation of margin loans - regulation impact statement

Part 1 - Introduction

5.1 Council of Australian Governments (COAG) reached an in principle agreement on 26 March 2008 that the Australian Government would assume responsibility for regulating mortgage credit and mortgage advice, including non-deposit taking institutions and mortgage brokers, as well as margin loans. On 3 July 2008, COAG agreed that the Australian Government would also assume responsibility for regulating all other consumer credit products and requested the COAG Business Regulation and Competition Working Group report back at the 2 October meeting with a detailed implementation plan for other credit.

5.2 Against that backdrop, in September 2008 the Australian Government decided to:

•

first, enact the Uniform Consumer Credit Code (UCCC) of the States and Territories and, where relevant, proposed amendments to the UCCC, as Commonwealth legislation;

-

the new national framework would be administered by the Australian Securities and Investments Commission (ASIC), which would be given enhanced enforcement powers;

•

secondly, to extend the scope of the current regulatory framework so that the new national consumer credit framework would:

-

include consumer lending for investment properties;

-

regulate the provision of margin loans;

-

require all providers of consumer credit and credit-related brokering services and advice to be members of an external dispute resolution body;

-

provide for a licensing regime requiring all providers of consumer credit and credit-related brokering services and advice to obtain a licence from ASIC;

-

require licensees to observe a number of general conduct requirements, including responsible lending practices;

-

regulate the provision of credit for small businesses; and

-

introduce specific conduct obligations, where warranted, for particular credit activities or products.

5.3 On 2 October 2008, COAG agreed to an implementation plan for the regulation of consumer credit. COAG agreed to a phased approach to reform, beginning with the transfer of responsibility key credit regulation, including the Uniform Consumer Credit Code as phase one. COAG also agreed to an implementation plan for phase two, the regulation of remaining areas of consumer credit, including payday lending (for example, pawnbrokers), credit cards, store credit, investment and small business lending, and personal loans, so that the reform package is completed in the first half of 2010.

5.4 A regulation impact statement (RIS) was prepared and considered in the context of consideration of the decisions by the Australian Government in September 2008. A copy of that RIS is at Chapter 6. The September 2008 RIS includes background information, including the market and regulatory environment for consumer credit and margin lending, and consultation processes that had been carried out to that date. It also includes a diagram of the two-phased approach to implementation (see Chapter 6), that was endorsed by COAG.

5.5 This RIS should be read in conjunction with the margin loan sections of the September 2008 RIS. It focuses on analysis of key measures in the Bill that substantively change the regulatory framework.

Part 2 - Consultation

Green Paper on Financial Services and Credit Reform

5.6 On 3 June 2008, the Government released the Green Paper on Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Regulation.

5.7 The Green Paper discussed the regulation of mortgages, mortgage brokers and margin loans, and proposed options for the Commonwealth taking over regulation in this area. With respect to other consumer credit products such as credit cards, personal loans and micro loans, the Green Paper asked for submissions on whether these products should also be regulated solely by the Commonwealth or whether there is a role for the States and Territories in this area.

5.8 Some 150 submissions were received in response to the Green Paper, and an overwhelming majority supported the Commonwealth assuming responsibility for the regulation of all consumer credit.

•

From the industry's perspective, this support was driven by the reduction in compliance burden that would be achieved by reducing the number of different regulatory regimes they are required to operate under.

•

From the consumer advocates' perspective, this support was driven by the better protections and efficiencies a consistent national regime offers.

Margin loans

5.9 Some 20 submissions in relation to margin loans were received in response to the Green Paper.

5.10 There was general support for the inclusion of margin loans as a financial product in Chapter 7 of the Corporations Act 2001 (Corporations Act) (Grant Thornton, Australasian Compliance Institute, Financial Planning Association, Australian Financial Counselling & Credit Reform Association Incorporated, Australian Institute of Credit Management).

5.11 It was noted that introducing a new specific regime (as opposed to extending Chapter 7) would be costly for both government and participants, would add further regulation to a system that already suffers from inefficient regulatory overlap and increase the risk of future inconsistency (Macquarie Bank, National Australia Bank, Australasian Compliance Institute, ANZ).

5.12 Some submissions called for further research and analysis before any action was taken and cautioned against a 'knee jerk' reaction to recent failures such as Opes Prime and Lift Capital, which involved products not sold by the majority of the industry (Australian Bankers Association, Securities and Derivatives Industry Association, Investment and Financial Services Association Ltd).

5.13 Subsequent to public consultation through the Green Paper, the Industry and Consumer Consultation Group assisted in developing the details of the regulatory regime. Further details of the Consultation Group's deliberations in relation to margin loans are noted below in the 'margin loans' section. The membership of the consultative group was expanded in relation to the margin loans discussion to include margin loan expertise.

5.14 It is noted that separate consultations with the same group are being held to develop a special product disclosure document for margin loans. On the Government's side, these discussions are being led by the Financial Services Working Group (the Working Group), which is a body composed of representatives from the Australian Treasury, the Department of Finance and Deregulation and ASIC. The Working Group was established in February 2008 and is tasked with simplifying and shortening disclosure documentation in financial services.

Part 3 - Regulation impact assessment

Impact assessment methodology

5.15 Impacts can be divided between three impact groups (consumers, business and government). Typical impacts of an option on consumers might be changes in access to a market, the level of information and disclosure provided, or prices of goods or services. Typical impacts of an option on business would be the changes in the costs of compliance with a regulatory requirement. Typical impacts on government might be the costs of administering a regulatory requirement. Some impacts, such as changes in overall confidence in a market, may impact on more than one impact group.

5.16 The assessment of impacts in this regulation statement is based on a seven-point scale (-3 to +3). The impacts of each option are compared with the equivalent impact of the 'do nothing' option. If an impact on the impact group would, relative to doing nothing, be beneficial, the impact is allocated a positive rating of +1 to +3, depending on the magnitude of the relative benefit. On the other hand, if the impact imposes an additional cost on the impact group relative to the status quo, the impact is allocated a negative rating of -1 to -3, depending on the magnitude of the relative cost. If the impact is the same as that imposed under the current situation, a zero score would be given, although usually the impact would not be listed in such a case.

5.17 The magnitude of the rating of a particular impact associated with an option has been assigned taking into account the overall potential impact on the impact group. The reference point is always the status quo (or 'do nothing' option). Whether the cost or benefit is one-off or recurring, and whether it would fall on a small or large proportion of the impact group (in the case of business and consumers), is factored into the rating. For example, a cost or benefit, even though large for the persons concerned, may not result in the maximum rating (+/-3) if it is a one-off event that only falls on a few individuals. Conversely, a small increase in costs or benefits might be given a moderate or high rating if it would be likely to recur or if it falls on a large proportion of the impact group. The rating scale for individual impacts is explained in the table below.

5.18 The ratings for the individual impacts compared to the status quo are then tallied to produce an overall outcome for the option. If it is positive, it indicates that the option is likely to produce a more favourable cost/benefit ratio than the status quo. If it is zero there would be no overall benefit from adopting the option, and if negative the option would provide overall a less favourable cost/benefit ratio than the 'do nothing' option. Ordinarily, options that have the highest positive score would be the favoured courses of action

5.19 What is classed as a 'large', 'moderate' or 'small' cost or benefit depends on the nature of the problem and options being considered. Of course, the costs and benefits associated with options to address a problem costing billions of dollars per year are likely to be of a much greater absolute magnitude than the costs and benefits of options for dealing with a rather modest issue that affects only a handful of persons. However, as all the ratings are made relative to the status quo/do nothing option for a particular problem, the absolute value of 'large' or 'moderate' or 'small' is not really important. All that matters is that within a problem assessment, the impacts of each option are given appropriate ratings relative to the status quo and each other. If that occurs, it will be sufficient for the methodology to yield an overall rating that assists in assessing the relative merits of options, from a cost/benefit perspective, to address the particular problem.

5.20 An example of the rating calculation for an option, using the seven-point scale ratings of impacts, is in the table below. The example is based on a purely hypothetical scenario that a new type of long-wearing vehicle tyre is being sold and marketed, but it has become apparent that the new style of tyres have a higher risk of exploding while in motion than conventional tyres. The example is designed merely to illustrate how the rating scale might be used to compare a proposal's costs and benefits option to the 'do nothing' option - it is not intended to be a comprehensive or realistic assessment of options to address such a problem.

Illustrative rating for the problem of a long-wearing tyre that may fail

Option A: Do nothing

Table 5.2

Option B: Ban on sale of the new tyre

Table 5.3

Option C: Industry-developed quality control standards

Table 5.4

5.21 In the above hypothetical example, Option C appears to have a better impact for consumers and a better overall cost/benefit rating than Option B.

Margin lending

Problem identification

5.22 There have been concerns that some margin borrowers are not aware of the extent to which margin lending contracts place the risk of changes to market conditions on them. The possibility of such borrowers suffering unexpected consequences is particularly high in volatile market conditions such as those experienced in the recent global financial crisis.

5.23 For example, some clients of the collapsed financial planning firm Storm Financial who had entered into margin loan arrangements borrowed funds against the equity in their homes and used them as a contribution to a margin loan. Some of these borrowers have fallen into negative equity in relation to their margin loans, and are now having to repay outstanding amounts on the margin loans as well as continuing to service the loan secured against their home. Where borrowers do not have additional sources of funds to do so, they are at risk of defaulting on their home mortgages and losing their homes.

5.24 Indications are that not all of these borrowers adequately understood the way that margin loans operate, including the potential consequences of margin calls. In addition, they may also not have been aware that they exposed themselves to the risk of losing their homes when they borrowed to fund the margin loan.

5.25 The Storm case illustrates the risks that can be attached to margin loans, and the fact that retail borrowers may not be fully aware of them when entering the arrangements.

5.26 Those factors were key considerations in the decisions of the Australian Government and COAG in 2008 to introduce a regulatory framework for margin lending. The issue being addressed in this RIS is the form of the new regulatory framework.

Objectives

5.27 The key objectives of a regulatory framework for margin lending are to achieve an outcome that: retail investors who enter into such arrangements are fully aware of the associated risks, and do not enter margin loans due to irresponsible conduct by lenders and/or inappropriate advice by financial advisers.

Options

Status quo

5.28 Currently margin loans are not treated as a specific product for regulatory purposes. Aspects of margin loan arrangements may fall under a variety of regulatory regimes, including the Corporations Act and the Code of Banking Practice. Other areas remain unregulated, such as the disclosure of key risk and other information to borrowers.

5.29 Margin loans will not be covered by the new consumer credit legislation in phase one, as that system does not cover investment loans (other than loans for investments in residential properties).

Option A: Include margin loans as a financial product under the Corporations Act and apply Chapter 7 with some modifications

5.30 Under Option A, margin loans would be defined as a financial product in Chapter 7 of the Corporations Act. As a consequence, financial services providers offering margin loans as one of their products would become subject to a comprehensive range of licensing, conduct and disclosure requirements. Providers and intermediaries would be covered by rules regarding external dispute resolution and compensation arrangements. The regulator would be ASIC.

5.31 Most of the participants (as lenders or providers) engaging in the margin lending market would already be familiar with the Chapter 7 obligations as they also supply and deal in other financial products that are covered by the Chapter 7 framework. That requires participants to:

•

have an Australian financial services licence (AFSL);

•

comply with general conduct standards, including the requirement to deal with investors efficiently, honestly and fairly;

•

have appropriate compensation arrangements in place for losses suffered by retail clients due to breaches of the law;

•

be members of an ASIC approved External Dispute Resolution (EDR) Scheme;

•

provide disclosure to their clients before and after a product is purchased, including providing a Product Disclosure Statement (PDS), a Statement of Advice and periodic statements on an ongoing basis;

•

have in place adequate arrangements for the management of conflicts;

•

ensure that they (and their employees) have adequate resources and are competent to provide the services; and

•

be subject to the enforcement provisions surrounding market manipulation, false or misleading statements, inducing investors to deal using misleading information, and engagement in dishonest, misleading or deceptive conduct.

5.32 Some modifications to Chapter 7 would be needed to adapt it to a margin loan context. In particular, there would be tailored obligations regarding the notification of margin calls, and the requirements would be expanded to cover a 'responsible lending' component (see Part 3.5 for details of the responsible lending requirements).

Option B: Incorporate margin loans in the new Commonwealth credit legislation

5.33 Under Option B, margin loans would be covered under the new Commonwealth credit legislation. This legislation will incorporate the current uniform State legislation covering consumer credit, the Uniform Consumer Credit Code (UCCC).

5.34 Under that regime, providers of credit for margin loans, and persons who suggest such facilities or assist consumers to enter them, would be subject to the following key obligations:

•

Persons who engage in credit activities would, initially, have to be registered with ASIC, and subsequently hold an Australian credit licence.

•

Entry standards for registration and licensing would be imposed which enable ASIC to refuse an application where the person does not meet those standards.

•

Registered persons and licensees would be required to meet ongoing standards of conduct while they engage in credit activities. Specific requirements would apply to both lenders and persons providing advice and assistance to consumers in relation to obtaining credit. Licensees would be subject to responsible lending requirements, under which an assessment must be made whether a proposed credit facility is unsuitable for a client.

•

Registered persons and licensees would have to be members of external dispute resolution schemes and have appropriate compensation arrangements in place.

•

ASIC would have the power to suspend or cancel a licence or registration, or to ban an individual from engaging in credit activities.

Impact analysis

5.35 The groups affected by the new regime for margin loans would be consumers of credit; industry participants including lenders and advisers; and the Government/ASIC.

5.36 It is estimated that there are between 1,000 to 2,000 financial planners active in margin loans, and many of them would not otherwise need to comply with the credit framework (though they would already be covered by Chapter 7 with respect to their other business lines). The number of lenders is much smaller, and is estimated not to exceed 15. Most lenders are authorised deposit-taking instructions which are already in possession of an AFSL for other parts of their business.

5.37 The main benefits of the two options are similar, and consist mainly of significantly improved consumer protection arrangements. Consumers will be the main beneficiaries under either option, as the licensing requirements will ensure that they will be dealing with lenders and other services providers that are properly trained and resourced. The new responsible lending requirements also operate under both options, and will mean that consumers are less likely to be given a margin loan which they cannot service. A very important benefit will be the requirement under both options for licensees to be members of external dispute resolution schemes, as access to the schemes will provide consumers with fast and free resolution of disputes and compensation claims where losses have been incurred.

5.38 Benefits to industry and government are of a lesser nature, but would also be similar under either option. For government, the improved consumer protection levels available under both options will in particular reduce the incidence of consumers requiring government assistance due to the provision of loans they cannot afford.

5.39 The main difference between the two options lies on the costs side. Most of the margin loan services providers are already holders of AFSL with respect to the other services they provide. This is in particular true for financial planners, which constitute the clear majority of services providers with respect to margin loans. These entities are therefore already familiar with the Chapter 7 regime, and have already established systems and processes that are tailored to that regime. The new credit regime, while in some aspects similar to the Chapter 7 requirements, also has some areas where significant differences occur. This is true in particular for the requirements relating to the provision of advice, which constitutes the main activity of financial planners. Option B would therefore require licensees to become familiar with a new regulatory regime, and to establish new systems and processes in parallel to what they have already put in place in order to comply with the Chapter 7 regime. Costs associated with Option B are therefore considered to be higher for industry than for Option A.

Table 5.5 : Status quo

Option A

Table 5.6

Option B

Table 5.7

Consultation

5.40 The issue of how margin loans should be regulated was discussed with the Industry and Consumer Consultative Group, as noted in the general consultation section above. Members of the group include:

•

government and the ASIC;

•

key industry associations representing lenders and financial planners;

•

key lenders, including both banks and brokers; and

•

representatives of the main EDR Schemes.

5.41 The first meeting of the group to discuss margin loans was held on 20 January 2009 and a number of further meetings were also held.

5.42 Main issues discussed at the meetings include:

•

whether the regulatory regime in Chapter 7 of the Corporations Act is suitable for margin loans, and if not what amendments are necessary to eliminate gaps and shortcomings;

•

what the appropriate definition of a margin loan should be;

•

what responsible lending requirements are appropriate in the context of margin loans; and

•

what the appropriate transitional arrangements should be, especially for licensing matters.

5.43 One of the main concerns raised by stakeholders was the need to limit the regulatory burden placed on business, and in particular to avoid unnecessary duplication of requirements for businesses already subject to licensing and regulation under the Corporations Act.

5.44 In the consultation meetings a range of issues were raised for Government to consider. The main issues include:

•

Developing an appropriate definition of a margin loan in order to ensure that a level playing field applies to all types of margin loans in the market. The key concern was to capture products offered by providers such as Opes Prime which are based on stock lending agreements rather than loan agreements. Additional members of the consultation group with specialised expertise in this area were recruited in order to ensure that an appropriate definition is provided.

•

Drafting responsible lending requirements that meet Government's policy objectives while minimising the regulatory burden on industry. This issue is being addressed in a variety of ways. While the obligation to assess the possible unsuitability of a margin loan is made clear, certainty on how to conduct the assessment is being provided to industry by listing a number of key matters that must be considered. Consideration is also being given to allowing lenders to rely on information or a recommendation provided by a licensed financial planner. Further guidance will also be provided in the explanatory material attached to the legislation, and ASIC may issue further guidance where appropriate.

•

Including transitional arrangements that give sufficient time to industry and ASIC for making adequate preparations, in particular for meeting the new licensing requirements, while addressing the Government's objective of a speedy introduction of the new regulatory regime. The draft legislation proposes a preparatory period during which lenders and services providers can prepare for submitting their licensing applications, and an additional period during which reduced regulatory requirements will apply in order to give industry time to meet all the requirements of the full Chapter 7 regime. ASIC is also considering ways of facilitating the licensing process, in particular in relation to meeting the training and competency requirements.

5.45 Taking account of this concern has been one of the key drivers in developing analysing the options relating to the regulatory treatment of margin loans.

Conclusion and recommended option

5.46 Options A and B would both provide overall benefits over the status quo, most of the benefits being in favour of consumers.

5.47 The main difference between Option A and B lies in the costs it imposes on business. Financial planners involved in margin loans would become subject to regulation under both Chapter 7 and credit regulation under Option B.

5.48 The recommended option is Option A, under which margin loans would be regulated by including them as a financial product in Chapter 7 of the Corporations Act with some adjustments to the legislation to take account of their special characteristics.

Part 4 Implementation and review

5.49 The recommended options would be implemented primarily through the introduction of the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009. Associated regulations would also be required.

5.50 There will be an opportunity to refine the margin loan regime established in phase one of the general credit project in the course of developing phase two, which is proposed to include investment credit.

5.51 The new margin loan regime would, like the regulatory framework for regulation of corporate regulation and financial services, be the subject of ongoing monitoring and review by the Australian Government.

Chapter 6 - Regulation impact statement - Margin loans - Attachment A

Executive summary

6.1 This is the regulation impact statement (RIS) referred to in paragraph 5.5 of Chapter 5. This RIS discusses:

•

The development and implementation of a national regulatory framework for consumer credit (including margin loans) to be undertaken in two stages. The key components of the proposed framework seek to establish consumer protection across all consumer credit products and services. The framework is proposed to be developed by enacting relevant State and Territory based consumer credit regulations as Commonwealth statute; and consolidating and enhancing the framework as necessary to reduce the regulatory burden on business and strengthen protection in specific areas.

•

Consultation on aspects of the proposed framework including the need for any enhancements (as outlined in the high level implementation plan and discussed herein) and its implementation.

Background

Consumer credit

6.2 Consumer credit is credit given by shops, banks and other financial institutions to consumers so that they can buy goods and services for personal, household or domestic purposes. Consumer credit encompasses for example, credit cards, payday loans and personal loans as well as mortgages.

6.3 The provision of consumer credit is a significant industry in Australia. As of June 2008, total consumer credit on issue, including securitisations, was $1,113.4 billion. Of this, housing credit on issue stood at $957.8 billion and other personal credit on issue was $155.6 billion. The largest sector of consumer credit is residential mortgages, which are estimated to account for over 86 per cent of all consumer loans.^[1]

6.4 Industry participants include providers (also known as lenders and issuers) and brokers/advisers who act as intermediaries between providers and consumers. Providers are increasingly relying on brokers to originate loans - in 2003 25 per cent of home loans were originated by mortgage brokers, this rose to 37 per cent in 2007.^[2]

6.5 The States and Territories currently regulate the provision of consumer credit by any provider through the Uniform Consumer Credit Code (UCCC).

6.6 While the provision of consumer credit is currently excluded from being a financial product under Chapter 7 of the Corporations Act 2001 (Corporations Act), Australian Securities and Investments Commission (ASIC) does regulate some consumer protection aspects of consumer credit. Specifically, the Australian Securities and Investments Commission Act 2001 (ASIC Act) prohibits conduct that is misleading or deceptive, or is likely to mislead or deceive, in relation to the provision of credit products and services.

6.7 The Council of Australian Governments (COAG) reached an in-principle agreement on 26 March 2008 that the Australian Government would assume responsibility for regulating mortgage credit and mortgage advice, including non-deposit taking institutions and mortgage brokers, as well as margin loans. Subsequently, on 3 July 2008, COAG agreed that the Australian Government would also assume responsibility for regulating all other consumer credit products and requested the Business Regulation and Competition Working Group report back at the 2 October meeting with a detailed implementation plan for other credit.

Current regulation of consumer credit

6.8 The UCCC's scope is limited to the provision of consumer credit for personal, household or domestic purposes. As such consumer credit sought for investment purposes and credit-related advice is not regulated.

6.9 The main provisions contained in the UCCC include the following:

•

provisions relating to the credit contract, including the form and content of the contract, how information about the contract is disclosed to the consumer, and how the contract may be changed;

•

special provisions relating to circumstances where consumers are affected by hardship, including powers of a court to intervene in such circumstances;

•

provisions relating to the enforcement of credit contracts, in particular what steps creditors must undertake before they can enforce a contract against a defaulting debtor;

•

extensive provisions relating to civil penalties for breaches of the UCCC;

•

special provisions regarding related sales and insurance contracts, as well as consumer leases; and

•

provisions relating to the advertising of credit, including requirements for including a comparison rate.

History of the Uniform Consumer Credit Code

6.10 In 1993, the States and Territories agreed that consumer credit laws should be nationally uniform. They entered a Uniform Credit Laws Agreement (the Uniformity Agreement) under which the UCCC was developed. The UCCC is template legislation, substantially uniform in all Australian States and Territories. It was enacted in Queensland by the Consumer Credit (Queensland) Act 1994 pursuant to the Uniformity Agreement, and in the other States and Territories through various arrangements.

6.11 Under the Uniformity Agreement, amending the consumer credit legislation requires approval by two thirds of the members of the Ministerial Council for Uniform Credit Laws (the Council), which is a subcommittee of the Ministerial Council on Consumer Affairs (MCCA). Membership of the Council consists of the State and Territory Ministers responsible for consumer credit laws. Changes to the Uniformity Agreement itself require the unanimous approval by the Council.

6.12 The Australian Government is not a member to the Uniformity Agreement and does not have a formal vote in matters relating to the UCCC. It is however invited to comment on all matters relating to the UCCC considered by the Council.

Outstanding UCCC projects

6.13 To address gaps in the UCCC and changes in the credit environment, MCCA has already decided to implement some specific amendments to the UCCC. These amendments are expected to be introduced prior to the Commonwealth assuming responsibility and therefore reflected in the UCCC which will be transferred over at that time. These are:

•

'Instalment' lending - amendments will ensure that vendor finance contracts for the purchase of land, 'conditional sale agreements' and 'tiny terms contracts' are brought within the scope of the Code.

•

Default notices - to improve the enforcement process for both lenders and borrowers by giving consumers clearer and more relevant and understandable information when they default.

•

Amendments to address 'fringe' lending practices - to address avoidance practices, increase the reviewability of credit fees and charges, improve regulator access to remedies, prohibit 'blackmail' securities and require lenders to supply basic direct debit information.

•

Reform of Mandatory Comparison Rates - to reform and streamline the operation of mandatory comparison rates (MCR) by responding to the independent review.

6.14 MCCA is also undertaking a number of projects in relation to the UCCC, which are in varying stages of development. These projects will be passed to the Commonwealth when it assumes responsibility and will be considered in the context of the national approach to the regulatory framework:

•

Reverse mortgages and other equity release products - to improve consumer outcomes in relation to equity release products.

•

Pre-contractual disclosure - to provide consumers with simple, accessible, relevant, concise and comprehensible pre-contract information.

•

Universal membership of External Dispute Resolution (EDR) Schemes - to explore the feasibility of requiring all credit providers to belong to an approved EDR Scheme.

•

Credit card responsible lending - to explore options to address credit card over-indebtedness.

Additional State and Territory specific regulation

6.15 By agreement among the States and Territories certain areas are exempted from the uniformity requirements applying to the UCCC. Additionally, some jurisdictions have moved unilaterally to address specific concerns. Accordingly, there are a number of differing requirements which are intended to augment the operation of the UCCC in the States or Territories in which they have application. For example:

•

Victoria, New South Wales, Western Australia and the Australian Capital Territory have some limited broker specific regulation. The Western Australian legislation requires all finance brokers to be licensed and members of an EDR Scheme.

•

New South Wales, Australian Capital Territory, Victoria and Queensland have legislation which limits the rate of interest and fees which can be charged on consumer credit products. South Australia expects to pass similar legislation by the end of 2008.

•

Victoria has passed legislation which is to commence in March 2009 which will subject credit contracts to the unfair contact terms provisions in the Fair Trading Act. Victoria has also passed legislation due to take effect in March 2009 which requires all credit providers to be members of an EDR Scheme. In addition, Victoria is examining the requirement for enhanced registration of credit providers.

•

South Australia is expected to pass legislation by the end of 2008 which will allow credit disputes to be heard in lower courts.

•

Tasmania is expected to introduce a Bill into Parliament shortly that will restrict the advertising of high cost credit products.

•

The Australian Capital Territory has legislation which imposes responsible lending requirements on credit cards providers.

Draft New South Wales National Finance Brokers Package

6.16 In addition to the UCCC and specific regulation mentioned above, the States and Territories have also agreed to national reforms aimed at regulating the finance broking industry, as recommended in the relevant decision-making RIS, subject to consultation on a draft Bill.

6.17 To this end, in November 2007, the New South Wales Government released the draft National Finance Brokers Package for public consultation on behalf of all jurisdictions.

6.18 The draft Finance Brokers Bill proposes to license all brokers to ensure that only reputable, skilled brokers transact with consumers and small businesses to obtain credit that suits their purposes and that they can afford. Applicants would be required to:

•

pass probity checks;

•

maintain mandatory membership of an approved EDR Scheme;

•

attain prescribed educational qualifications or skills (not below a Certificate IV); and

•

obtain mandatory professional indemnity insurance.

6.19 In addition, the draft Bill imposes a requirement that brokers confirm a person's capacity to repay before applying for credit; disclose certain information and have a reasonable basis for any recommendation. Further, brokers would not be able to charge a fee before credit was obtained.

6.20 Over 100 submissions were received and consultations conducted by New South Wales have revealed broad support for the draft Bill. However some concerns remain in relation to a few specific provisions, namely the capacity to repay, stay of enforcements and professional indemnity requirements.

6.21 In light of the COAG decisions it has been agreed that the Commonwealth will take over the project, and conduct further consultation on the remaining concerns. In accordance with the conditional approval given to the project by the Office of Best Practice Regulation, an updated assessment of the regulatory impact of the proposed regime will be undertaken once the details are established.

Margin loans

6.22 Margin lending describes an arrangement under which investors borrow money to buy financial products (such as listed shares, fixed interest securities and units in managed funds). The underlying financial products are then used to secure the loan for those products. The amount the investor can borrow depends in the loan-to-valuation ratio (LVR) offered by a lender of each stock.

6.23 As with most other loans, investors must pay interest on the amount borrowed under a margin loan, however regular repayments are not generally required. Instead, repayments are only required when the investment is subject to a 'margin call'. This occurs where the market value of the investment falls below the level agreed under the contract. A margin call requires the investor to take appropriate action to return the LVR to the agreed limits stated under the contract. This can be done by paying extra cash, selling some of the assets or giving the lender additional security. The lender is under no obligation to contact the investor when a margin call is made. The responsibility falls on the investor to take appropriate action in accordance with the timeframes, potentially less than 24 hours, as prescribed in the margin loan agreement.

6.24 There has been a rapid growth in the value of margin loans with the total value increasing from under $5 billion in June 1999 to over $37 billion in December 2007. More recently the total value of margin loans has dropped back to around $32 billion in response to the recent market turbulence. Consistent with the growth over the past nine years, the number of clients taking out margin loans has increased from 87,000 in 2000 to 202,000 in 2008.

Current regulation of margin loans

6.25 Margin loan facilities are based on complex contractual arrangements between the lender and the client. Primary disclosure of the terms and conditions governing the loan occurs through the lending agreement signed between the two parties.

6.26 Margin loans consist of a credit component and an investment component. Where the investment aspect involves a financial product such as shares, Australian Government regulation in the form of Chapter 7 of the Corporations Act applies.

6.27 In addition, where the investment aspect involves a listed share, Australian Securities Exchange (ASX) Listing Rules might apply. The Listing Rules set standards of behaviour for listed entities and include ASX's continuous disclosure requirements.

6.28 Misleading and deceptive conduct in relation to margin lending is regulated under the ASIC Act. Under this legislation ASIC can, for instance, take action against misleading advertising or misleading statements made by financial advisers in relation to the provision of margin loans.

6.29 The credit component of the margin loan transaction is currently largely unregulated. Margin loans are not regulated by the States and Territories under the UCCC, as credit provided for investment purposes is excluded.

6.30 The Corporations Act excludes all credit under the agreement with the States and Territories. However, where a margin loan is provided through a financial planner as part of an overall financial plan, ASIC considers that the Corporations Act applies to all the elements of the plan, including the margin loan facility as it is considered to be an investment vehicle.

6.31 As margin loans are supplied by a variety of providers, including banks, various industry standards, such as the Australian Bankers' Association Code of Banking Practice, may apply.

6.32 The Code of Banking Practice, which applies to personal and small business bank customers, sets out the banking industry's key commitments and obligations to customers on standards of practice, disclosure and principles of conduct for their banking services. This Code is not legislation; however, banks that adopt this Code are contractually bound by their obligations under this Code.

6.33 If the provider of a margin loan has adopted the Code of Banking Practise there is an obligation on the bank to exercise care and skill in determining a customer's ability to repay the loan. Under this Code members are required to provide both an internal and EDR Scheme for customer disputes.

6.34 However, margin loans are increasingly being provided by non-deposit taking institutions. Clients of these lenders do not benefit from the protection of the Code of Banking Practice.

Financial Services Reform - Chapter 7 of the Corporations Act

6.35 The Financial Services Reform Act 2001 (FSR) put in place a regulatory framework for the provision of a wide range of investment and risk management style financial products and advice related to those products, including securities, derivatives, general and life insurance, superannuation, deposit accounts and non-cash payments. This regime was incorporated as Chapter 7 of the Corporations Act.

6.36 The regulatory framework introduced under Chapter 7 sought to promote confident and informed decision making by consumers of financial products and services while facilitating efficiency, flexibility and innovation in the provision of those products and services; fairness, honesty and professionalism by those who provide financial services; fair, orderly and transparent markets for financial products; and the reduction of systemic risk and the provision of fair and effective services by clearing and settlement facilities.

6.37 The FSR regime provides for:

•

All financial services providers are licensed and subject to uniform obligations and requirements by ASIC in the provision of the services for which they are licensed.

•

All providers of financial services (including issuing, broking and advice) are uniformly regulated in the provision of the regulated financial products (noting tailoring of provisions for specific products and circumstances).

•

Minimum standards such as training, disclosure, considerations in giving financial product advice, and general conduct are required of licensees in their dealings with retail clients:

-

there are tiered training requirements, dependent on the level of advice and type of product being provided;

-

membership of an EDR Scheme is compulsory;

-

providers are required to conduct their services efficiently, honestly and fairly;

-

there must be a reasonable basis on which providers base their advice; and

-

disclosure of information to retail clients in relation to the provider's financial services business (in a Financial Services Guide), financial services advice (in a Statement of Advice) and financial services products (in a PDS) is required.

•

All providers must have adequate compensation arrangements (generally professional indemnity insurance).

6.38 The Government has tasked the Financial Services Working Group to reform financial services disclosure documents in order to introduce simple, standard and readable documents which are more easily understood by consumers and allow for greater ease of product comparability.^[3] Once implemented, these reforms may reduce compliance burden involved in complying with FSR and therefore produce cost savings.

Problem identification

Consumer credit

6.39 The inter-jurisdictional processes for changing the UCCC have led to prolonged delays in implementing necessary reforms leading in some cases to their effective abandonment. Amending the UCCC is a slow and arduous process requiring agreement among all jurisdictions. The protracted time frames for developing national finance broker regulation and for closing off some identified loopholes in the UCCC such as those related to the regulation of fringe lenders, are cases in point. Such delays have compromised the capacity of the regulatory regime to respond to market developments and the effectiveness of protections for those acquiring credit products and services, particularly in a market where products and practices are evolving rapidly.

6.40 The introduction of various State and Territory specific regulations has resulted in inconsistent consumer protection and has added red tape and unnecessary compliance costs on service providers. While the UCCC notionally provides for consistent administration and enforcement of a consumer protection code nationally, jurisdictions have unilaterally imposed additional requirements separate from the UCCC. Consequently, protections available to consumers acquiring credit are not uniform across jurisdictions and have resulted in providers who operate nationally or in multiple jurisdictions incurring additional compliance costs arising from the need to vary their business practices. Where this occurs, complexity and additional costs are imposed on consumers and businesses.

6.41 There is evidence that some consumers who access credit through brokers are not achieving appropriate outcomes. The concerns with the lack of regulation of brokers are well documented in the RIS prepared for the National Finance Broking Regulation. For example, the number and range of credit products currently offered by providers are too numerous and too complex to allow the majority of consumers to make fully informed decisions. As a result many consumers are turning to brokers. However, the use of a broker may not produce the best outcome, and could lead to considerable detriment, for the consumer. This is because consumers are often dependent on the broker's skill and expertise and therefore vulnerable to exploitation. Unfortunately, it appears some brokers may provide inappropriate advice and this occurs for a variety of reasons, including a lack of skill, remuneration based incentives and unscrupulousness.

6.42 There is evidence that some consumers are experiencing financial difficulties caused by over-indebtedness. There are a number of causes of this, for example, some consumers do not appreciate the implications of obtaining credit, and/or have an unrealistic appreciation of their capacity to repay. In addition, some providers' assessment practices maximise the amount of credit able to be granted but which cannot be repaid by the consumer without substantial hardship. The concern with the lack of a requirement on participants to establish a consumer's capacity to repay are well documented (albeit in a limited context) in the RIS on responsible lending practices in relation to consumer credit cards.

6.43 Consumers' access to dispute resolution mechanisms other than the Courts is limited under the UCCC as participants are not required to be members of an EDR Scheme. Therefore consumers who are unable to resolve a dispute directly with a provider who is not voluntarily a member does not have access to dispute resolution services outside of the court process. Court processes are often complex, time consuming and costly and therefore not a particularly viable solution.

6.44 Currently consumers have only limited protections when obtaining credit for investment or small business purposes. The UCCC does not regulate credit provided for investment purposes, nor credit provided to small businesses. That means, for example, the mortgage over a person's home is regulated under the UCCC but the same person's mortgage over another home, for investment purposes, is not. That person is not necessarily any more knowledgeable when entering into that contact, and may have used their primary residence as security, but does not have access to the protections offered by the UCCC. Furthermore, a loan to small business may also be used indirectly to fund personal consumption or be secured by personal assets, particularly in the case of an unincorporated operator, but is not afforded protections under the UCCC. The FSR regime only regulates investment in financial products (for example, shares but not real property) and related advice - not the credit used to obtain it.

6.45 There is evidence that some consumers are poorly informed about the key features and risks of certain credit products. The UCCC contains a number of provisions regulating disclosure, mainly pre-contractual which focuses on the contractual obligations rather than the features and risks of the actual product. As such, it appears that the existing disclosure requirements may not be sufficient to prevent confusion and financial loss.

6.46 The penalty provisions in the UCCC are largely limited to civil remedies for breaches of the legislation. There is no provision for a regulator to intervene through administrative action. In addition, the regulator does not have standing in court. This means the regulator cannot deal with minor breaches of the legislation in a manner commensurate with their impacts or take action on behalf of consumers as a general population.

Margin loans

6.47 With the strong performance of the ASX over the recent years, the instance of margin calls has been very low. However, with the stock market moving into a time of more uncertain growth, there has been some concern surrounding retail clients' understanding of how their margin loan product operates. Recent market volatility has been alarming for small investors, particularly those who have only experienced positive markets previously. This has highlighted the current absence of consumer protection regulation concerning margin loans, particularly in relation to retail investors.

6.48 There are serious concerns that consumers are not necessarily aware of the extent to which margin lending contracts place the risk of changes to market conditions on them. In particular, some contracts allow the lender to unilaterally withdraw the facility or withdraw a particular company's stock from their acceptable list of equities over which margin lending is accepted, thereby forcing full repayment.

6.49 Furthermore, it is not clear that investors fully understand how the LVR ratio works and that the loan provider is able to change this in a very short period of time.

6.50 There are also serious concerns that marketing material, separate from the contract itself, highlighting 'bull market' gains make margin loans seem much simpler than they in fact are and do not fully disclose the downside risks.

Policy objectives

6.51 To give effect to the COAG decisions of 26 March and 3 July 2008, in that the Australian Government will assume responsibility for the regulation of consumer credit and margin loans.

6.52 To provide a comprehensive, nationally consistent consumer credit regime, by addressing conflicts or gaps in the existing consumer credit regime where there is evidence that consumers are suffering loss and other detriment or an unnecessary compliance burden is being placed on business.

6.53 To determine the most appropriate way to handle margin loans to ensure people who invest through them are aware of the associated risks.

6.54 To reduce the regulatory burden on business, better protect the interests of consumers and ensure the regulatory regime contributes to ensuring the Australian economy is modern and strong.

Implementation options

Implementation scope

6.55 The terms of the COAG agreement are quite broad and allow the Commonwealth to determine the precise scope and mechanism for implementing the national regulation of consumer credit and margin loans. Although the Commonwealth has not previously regulated consumer credit the States and Territories, as well as industry participants and consumer groups, have substantial knowledge of the issues involved and will be used to inform the development of the national regime.

6.56 A primary weakness of the existing UCCC is its inability to respond to market developments in a timely manner because of the co-operative amendment process. This will be overcome when enacted as Commonwealth law, in part because, where possible, it will be drafted on a principles basis so that it does not necessarily need to be amended to regulate new products and behaviours. In addition, a national regime will provide consumers and participants with consistency by reducing duplication and inconsistent obligations.

6.57 Despite those inherent improvements, given the concerns identified above it would seem that simply enacting the UCCC as Commonwealth law will not be sufficient to comprehensively regulate consumer credit in a way which achieves the Government's objectives. Some potential enhancements which could be made have been identified below. Their necessity, and the impacts their introduction would have, will be evaluated on the basis of views solicited through further consultations.

Potential enhancements to the regulation of consumer credit under the national regime

6.58 The scope of the regime may need to be framed so as to capture additional transactions and services.

6.59 The UCCC only regulates the provision of consumer credit. That is, the UCCC does not regulate the provision of credit-related advice, and excludes credit provided to consumers for investment purposes and loans made to small businesses. This means that some transactions undertaken by consumers are outside of the protections offered by the UCCC.

6.60 However, the draft Finance Brokers Bill has been specifically crafted to regulate the provision of advice by brokers/advisors in all jurisdictions in relation to all consumer and small business credit.

6.61 The absence of a comprehensive approach for regulating credit advice is widely acknowledged as a key deficiency of the current regime. Changes in the credit environment and the increased availability of a range of products being offered by a range of lenders have seen consumers rely more heavily on finance brokers/advisors when considering their lending options, yet there is no regulation of these transactions. That is, the UCCC only regulates the actual lending portion of the transaction and not the advice. There is no regulatory requirement that advice is appropriate for the consumer and there is evidence that in its absence consumers have suffered detriment.

6.62 Consumer borrowing for investment purposes is not regulated by the UCCC. Individual investors are often not sophisticated and consider investing in real property to be a lower risk activity than other investments. Such investment is often long term and involves large sums of debt. Past increases in property prices and average household incomes have promoted consumer confidence which has led to increased borrowing to fund investment. However recent downturns in property and financial markets have left some investors with reduced levels of equity and liquidity. These investment credit contracts are not subject to regulatory oversight and protection. By comparison, the FSR regime regulates investment in financial products, and advice in relation to it.

6.63 Similarly, small business operators are not necessarily sophisticated investors. Small businesses may not have sufficient resources to obtain detailed advice, negotiate favourable contract terms or engage in costly and complex legal arrangements to resolve disputes. The extension of protections under the national credit regime to small businesses is similar to the scope of the FSR regime for financial products.

6.64 In contrast to the UCCC, Chapter 7 of the Corporations Act regulates the provision of financial services products (such as shares but not real property) and advice related to those products provided to all retail clients.

6.65 The need to extend the scope of the legislation to other transactions and services has not yet been determined and will be the subject of consultation.

All industry participants may need to be licensed

6.66 The UCCC does not contain a licensing regime. However, in recognition of the need for, and benefits of, licensing the States and Territories have agreed to license the brokers/advisers of all consumer and small business credit in all jurisdictions, as proposed in the draft Finance Brokers Bill.

6.67 A licensing regime generally restricts entry to those people who are appropriately skilled and of good character. Licensing is a mechanism by which obligations can be imposed on participants. In addition, it provides for more effective and efficient enforcement. It allows the population to be known to the regulator, who can then ensure that required standards are met and impose penalties for non-compliance. Experience suggests that, in the absence of a licensing regime, unscrupulous or unskilled people can operate in the market for some time before being identified. Once identified there is often no mechanism to resolve disputes outside of the courts.

6.68 There is wide ranging community and industry support for the introduction of a comprehensive licensing regime (for example, Finance Sector Union, Credit Ombudsman Service, Finance Brokers Association Australia, Mortgage & Finance Association Australia).

6.69 In addition, the Productivity Commission recommended a licensing system for finance brokers, and a licensing or registration system for credit providers (with both requiring participation in an approved EDR Scheme). Chapter 7 requires all financial service providers be licensed.

6.70 Should a licensing requirement be included in the national regime, it may be inappropriate to only license brokers/advisors (as proposed in the draft Finance Brokers Bill) and not providers as well, given they can also interact directly with consumers. However the obligations imposed may vary depending on the role of the participant.

Industry participants may need to provide additional disclosure to consumers.

6.71 The UCCC already requires certain disclosure, mainly pre-contractual. However this has not been adequate to properly inform consumers of all the risks associated with specific credit products, such as reverse mortgages.

6.72 Without all relevant information, consumers are not able to make well reasoned decisions. Making inappropriate decisions can lead to financial stress.

6.73 In recognition that some people may not understand the risks involved with reverse mortgages the States and Territories are currently considering the need for specific disclosure. A consultation RIS is being prepared by the States on this matter.

6.74 In addition, the States and Territories have commissioned research into pre-contractual disclosure to ensure it is simple, accessible, relevant, concise and comprehensible.

6.75 Further, the proposed amendments to address 'fringe' lending practices include requiring additional disclosure in relation to direct debit authorities and clarifying disclosure requirements for annual percentage rates.

6.76 The need to impose any additional disclosure requirements, such as ongoing or product specific disclosure requirements, will be considered in the second phase.

The expected conduct and behaviour of industry participants in relation to their dealings with consumers may need to be regulated.

6.77 The UCCC contains some conduct requirements. However, numerous submissions to various consultations papers have suggested these provisions are not sufficient. There is evidence that practices such as 'equity stripping', 'churning', the provision of inappropriate advice, the provision of credit to consumers who can not afford to repay it and the charging of excessive fees have occurred, to the detriment of consumers.

6.78 The consumer is in a position where they are dependent on the broker's skill and expertise and therefore vulnerable to exploitation. It is in the industry's interest that consumers value the services which are available. One way to achieve consumer confidence is to ensure market participants behave in an appropriate manner.

6.79 The application of general conduct requirements is a principled (as opposed to prescriptive) method of addressing concerns which may otherwise be manifested as specific obligations and products features.

6.80 The concept of requiring responsible lending practices was consistently raised by consumer advocacy groups (such as Care Inc Financial Counselling & Consumer Law Centre ACT, Consumer Credit Legal Centre NSW, ACTU and the Financial Sector Union) in responses to the Green Paper.

6.81 The draft Finance Brokers Bill proposes to address this issue in part by imposing a requirement that the consumer's capacity to repay be considered before any credit product is recommended (a RIS was prepared). The draft Finance Brokers Bill also requires that the advisor/broker has a reasonable basis for recommending a particular credit product.

6.82 In addition, the States and Territories are considering imposing additional conduct requirements, in the form of responsible lending provisions, on credit card providers to address concerns with over-indebtedness. A consultation RIS was prepared.

6.83 Chapter 7 of the Corporation Act requires providers conduct their services efficiently, honestly and fairly.

6.84 If additional conduct requirements were to be introduced it is envisaged that they would oblige participants to observe a number of general conduct requirements such as those imposed by Chapter 7. In addition, credit-specific requirements, such as establishing a person's capacity to repay and banning specific predatory lending practices, could be imposed. The need for any additional conduct requirements, and the specifics of the obligations they would impose if adopted, have not yet been determined and will be the subject of consultation.

Industry participants may need to provide access to appropriate dispute resolution services.

6.85 Under the UCCC membership to EDR Schemes is voluntary. Tribunals have been established to deal with complaints related to consumer credit. Western Australia, and more recently Victoria, are the only jurisdictions to have introduces legislation which requires brokers/advisors to be members of an external dispute resolution scheme.

6.86 The importance of mandating access to an EDR Scheme is that they provide consumers who are unable to resolve a dispute directly with their provider with a free, fair and independent dispute resolution mechanism. The alternative is often the complex, time consuming and costly court process which is not particularly viable.

6.87 In the absence of a legislative requirement several industry associations, such as the Mortgage & Finance Association of Australia and the Australian Bankers' Association Code of Banking Practice, require their members be members of EDR Schemes.

6.88 The draft Finance Brokers Bill proposes to mandate membership of approved EDR Schemes for all brokers. Chapter 7 mandates membership of an ASIC approved EDR Scheme.

6.89 In recognition of the value of access to EDR Schemes, the States and Territories had commenced examining the feasibility of requiring all credit providers to belong to an approved EDR Scheme. However, this work was postponed following the COAG decisions.

6.90 The need to impose a requirement to provide access to dispute resolution services has not yet been determined and will be the subject of consultation. If such a requirement were to be introduced it is envisaged that access to EDR Schemes would be free to consumers and similar to the schemes which operate for the purposes of Chapter 7 of the Corporations Act.

The regime will need to be enforced by a national regulator, namely ASIC, in a way which minimises avoidance of the requirements.

6.91 The UCCC is enforced by each State and Territories' Fair Trading Office. The UCCC contains a range of civil penalties. The regulators lack the ability to intervene quickly and to act unilaterally in instigating court proceedings against persons acting inappropriately or failing to meet required standards.

6.92 The amendments to address 'fringe' lending practices proposed by the States and Territories recommend giving government consumer agencies standing in court proceedings.

6.93 Moving to a single national regulator is consistent with having a national scheme. ASIC is the logical choice, given its experience in enforcing the Corporations Act and its existing infrastructure and relationships with financial services providers. This conclusion is supported by the fact that ASIC was repeatedly identified as the appropriate regulator in submissions to the Green Paper and by the Productivity Commission in its report of May 2008.

6.94 The alternative national regulator, the Australian Competition and Consumer Commission, has little experience in the regulation and licensing of financial services or credit, nor the established relationships with those providers. Further, it would be expected that the incremental cost of extending ASIC's oversight to credit would be less than that required to extend the Australian Competition and Consumer Commission functions to credit regulation.

6.95 The States and Territories have indicated they do not want a continuing enforcement role once the Commonwealth assumes responsibility for credit. However they reserve the right to enforce generic consumer protection laws where applicable.

6.96 The need for any enhancement to ASIC's enforcement powers (such as the ability to impose administrative and criminal penalties, have standing in court cases and the ability to ban industry participants), have not yet been determined and will be the subject of consultation.

Proposed regulation of margin loans under Chapter 7 of the Corporations Act

6.97 The proposed regulation of margin loans under Chapter 7 is included in phase one of the proposed implementation plan.

6.98 The Simplifying and Standardising Financial Services and Credit Regulation Green Paper proposed three options for margin loans: 1) maintain the status quo; 2) include margin loans as a financial product under the Corporations Act and apply the Chapter 7 regime; and 3) develop a separate regulatory regime for margin loans.

6.99 A number of submissions were received however, whether margin loans need to be regulated, and if so the appropriateness of Chapter 7 to do so, has not yet been determined and will be subject to further consultation.

Implementation mechanisms

6.100 Due to constitutional limitations, the preferred approach to any regulation of credit would be to amend the Corporations Act. There are two options for the implementation of Commonwealth regulation of consumer credit.

Option A

6.101 Extend Chapter 7 of the Corporations Act to regulate the provision of all consumer credit products and related advice including consumer mortgages for investment purposes, and loans to small businesses, as a financial product.

Option B

6.102 Enact the UCCC (including outstanding projects) to the extent possible and the relevant provisions of the draft National Finance Brokers Bill, supplemented with additional licensing, conduct and disclosure provisions as required to comprehensively regulate the provision of consumer credit and related advice, including consumer mortgages for investment purposes, and loans to small businesses as a new chapter of the Corporations Act.

Assessment of impacts

Impact group identification

6.103 The groups affected by the amendments are consumers of credit; industry participants including providers and brokers/advisers; and the Government and ASIC.

Assessment of costs and benefits

Option A: Extend Chapter 7 of the Corporations Act to include all consumer credit products.

Table 6.1

Option B: Enact relevant provisions of the UCCC and the draft Finance Brokers Bill, supplemented as required, as Commonwealth law

Table 6.2

Preferred approach - Option B

6.104 Despite its gaps, the UCCC provides a well developed foundation for the regulation of consumer credit, which is well known by industry and consumers. Moving the UCCC under Commonwealth control resolves many of its weaknesses. Further the UCCC framework can be enhanced with additional licensing, conduct and disclosure provisions, drawn from the draft Finance Brokers Bill and supplemented as required, to provide for the comprehensive regulation of consumer credit.

6.105 Chapter 7 of the Corporations Act does not contain the necessary credit specific provisions, such as dealing with defaults, repossession and hardship requirements. In addition, its licensing, conduct and disclosure frameworks are specifically designed for the regulation of financial services that are not necessarily appropriate or applicable to credit products given the different risks involved. This is consistent with the views expressed by the financial sector in response to the Green Paper. However, Chapter 7 may provide a basis from which to produce the additional regulation necessary to supplement the UCCC and draft Finance Brokers Bill.

Business cost calculator

Consumer credit

6.106 Until the details of the proposed national regime (including the licensing, conduct and disclosure requirements) are decided it is difficult to estimate the cost of compliance to business. It is expected that there will be an initial cost to businesses in transitioning to the new system, such as obtaining their licence. In addition, it is expected that there will be on-going costs involved in disclosure, compliance, training and membership of an EDR Scheme.

6.107 Consultations to date have suggested that implementation costs would be minimised if the Commonwealth adopted the UCCC with minimal changes (for example, Legal Aid NSW & QLD and Australian Finance Conference). The proposed regime will be subject to further consultation in order to achieve a design which minimises compliance costs while delivering enhanced protections to consumers.

6.108 It should be noted that these costs are offset in part by savings from no longer having to comply with multiple State and Territory based regulation, which is often duplicated or inconsistent. In addition, a national regime of consumer credit regulation will allow, over time, for streamlining and consolidation.

Margin loans

6.109 Until the details of the regulation, if any, for margin loans are decided it is difficult to estimate the cost of compliance to business. Consultations noted that introducing a new regime, as opposed to extending Chapter 7, would be more costly for both businesses and government.

6.110 Traditionally, margin loans have been sold through AFS licensees. Although the provision of margin loans, or advice in relation to them, are not currently subject to the obligations imposed by Chapter 7 the extension of those requirements would not be expected have a large impact for existing AFS licensees.

6.111 If margin loans were to be regulated under Chapter 7, it is expected that the majority of the cost will be borne by those industry participants who are not already AFS licensees, and that some of those costs would be passed on to consumers.

6.112 If margin loans were to be regulated, Option 3 would appear to result in the creation of a separate regime for margin loans that would unnecessarily mirror Chapter 7, creating regulatory overlap for businesses offering margin loans and other financial products. This would create inefficiencies for businesses that would be required to obtain separate licences for different products and develop disclosure documents for those products under different regimes.

Staging

6.113 The national regime could be implemented as either a single step or a staged process.

6.114 Under a single step process a national regulatory regime could be introduced only after all of the work had been done to refine the existing regime, undertake the necessary consultation and approval processes, and draft the entire package of legislation. This would delay the implementation of any reform for several years, during which time the current problems with the regulatory regime would remain unaddressed.

6.115 Alternatively, a national regulatory regime could be introduced in stages. This would involve the early introduction of Commonwealth law addressing the most urgent problems (such as mortgage credit and advice, margin loans and other matters), followed by the later introduction of additional features, after further consideration.

6.116 The first phase would include the enactment of the UCCC, relatively unchanged, as Commonwealth law which ensures continuity and certainty for both business and consumers. As industry currently complies with the UCCC there would be minimal operational difference in transferring existing legislation to the Commonwealth. It is expected that several of the currently outstanding projects will have already been enacted as amendments to the UCCC by this time.

6.117 Depending on the outcomes of consultation, the key changes from the existing regime introduced in phase one would be:

•

the extension of the regime to consumer mortgages for real property;

•

the licensing of all industry participants, which could be based on the provisions in the draft Finance Brokers Bill;

•

compulsory membership in an EDR Scheme; and

•

the introduction of general conduct provisions, including the requirement that a person's capacity to repay be considered when determining eligibility for credit.

6.118 ASIC would also assume responsibility from the State and Territory Fair Trading Offices for regulating consumer credit in phase one. This would enable ASIC to commence producing educational material and licensing industry participants, giving industry time to transition into the new scheme. In addition, it would immediately reduce duplication or inconsistency in regulatory burden inherent in complying with multiple State and Territory jurisdictions.

6.119 The second phase would focus on determining the need for specific conduct, disclosure and product requirements and the extension of the scope of the law to cover remaining investment loans and loans to small businesses.

6.120 Managing the single stage implementation of such a large reform is considered to be more difficult than a staged process. These difficulties were demonstrated during the introduction of the FSR regime in 2001. Industry participants and the regulator were overwhelmed by the quantum of changes and the compressed timeline in which they were required to comply with the new regime.

6.121 The inbuilt delay in implementing the reform as a single package is undesirable, given the pressing concerns with certain aspects of consumer credit. Further, should any aspect of a single package be delayed the entire project would be delayed. In contrast, a staged process ensures that important and non-controversial aspects can proceed urgently.

6.122 In response to the Green Paper several submissions noted that, should the Commonwealth take over the regulation of all consumer credit, a staged implementation would be advisable (for example, Financial Services Ombudsman, Financial Planning Association).

Consultation

Consumer credit

Green Paper on Financial Services and Credit Reform

6.123 On 3 June 2008, the Government released the Green Paper on Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Regulation.

6.124 The Green Paper discussed the regulation of mortgages, mortgage brokers and margin loans, and proposed options for the Commonwealth taking over regulation in this area. With respect to other consumer credit products such as credit cards, personal loans and micro loans, the Green Paper asked for submissions on whether these products should also be regulated solely by the Commonwealth or whether there is a role for the States and Territories in this area.

6.125 Some 150 submissions were received in response to the Green Paper, and an overwhelming majority supported the Commonwealth assuming responsibility for the regulation of all consumer credit.

•

From the industry's perspective, this support was driven by the reduction in compliance burden that would be achieved by reducing the number of different regulatory regimes they are required to operate under.

•

From the consumer advocates' perspective, this support was driven by the better protections and efficiencies a consistent nation wide regime offers.

6.126 Most submissions supported the enactment of the UCCC, including the outstanding projects, as Commonwealth legislation and identified ASIC as the appropriate regulator.

•

Licensing (with compulsory membership of EDR Schemes) and disclosure requirements were seen as key features. In addition, several submissions highlighted the need for the concept of responsible lending, and consideration of capacity to repay requirements.

•

A common view was that putting lenders and brokers into the FSR regime was inappropriate as selling and/or providing credit was fundamentally different to providing and/or advising on investments (Mortgage & Finance Association Australia; Gadens lawyers; ABA).

•

Of the few submissions that suggested Chapter 7 of the Corporations Act would be appropriate, most commented that the existing requirements would require modification to apply appropriately to credit products and providers (AXA Asia Pacific).

•

Several submissions supported, or understood the need for, staged implementation (Financial Services Ombudsman, Financial Planning Association).

•

It was suggested that the implementation costs would be minimised if the Commonwealth adopted the UCCC with minimal changes (Legal Aid NSW and QLD and Australian Finance Conference).

Other consultations, reviews and regulation impact statements

6.127 The Government has established an implementation taskforce consisting of officials from the Commonwealth Treasury, ASIC and the States and Territories in order to progress the COAG decisions in relation to consumer credit.

6.128 The New South Wales Government has undertaken extensive consultation on the draft NSW National Finance Brokers Package. These consultations have identified consensus on a majority of provisions. The Commonwealth Treasury will undertake further consultation on the disputed provisions. (A decision-making RIS was given conditional clearance by the Office of Best Practice Regulation in 2006.)

6.129 The New South Wales Government released a consultation RIS on responsible lending practices in relation to consumer credit cards on 22 August 2008. Submissions are due by 3 October.

6.130 A decision making RIS for fringe credit providers was approved by the Office of Best Practice Regulation in 2006.

6.131 An inquiry in 2007 into home lending practices and procedures by the House of Representatives Standing Committee on Economics, Finance and Public Administration recognised the importance of consistently regulating non-bank lenders and mortgage brokers by recommending that the Commonwealth take over the regulation of credit including the regulation of mortgages. The Committee suggested that credit be included in the definition of a financial product for the purposes of the Corporations Act.

6.132 The Productivity Commission released its final report on Australia's Consumer Policy Framework (including regulation of consumer credit) on 8 May 2008. It recommended that the Commonwealth take over the regulation of credit and develop generic consumer law.

6.133 KPMG Consulting undertook consultation and released a report NCP Review of the Consumer Credit Code in December 2000, which has been the catalyst for the proposed amendments to the default notices and vendor terms provisions.

Margin loans

6.134 Some 20 submissions in relation to margin loans were received in response to the Green Paper.

6.135 There was general support for the inclusion of margin loans as a financial product in Chapter 7 of the Corporations Act (Grant Thornton, Australasian Compliance Institute, Financial Planning Association, Australian Financial Counselling & Credit Reform Association Incorporated, Australian Institute of Credit Management).

6.136 It was noted that introducing a new specific regime (as opposed to extending Chapter 7) would be costly for both government and participants, would add further regulation to a system that already suffers from inefficient regulatory overlap and increase the risk of future inconsistency (Macquarie Bank, National Australia Bank, Australasian Compliance Institute, ANZ).

6.137 Some submissions called for further research and analysis before any action was taken and cautioned against a 'knee jerk' reaction to recent failures such as Opes Prime and Lift Capital, which involved products not sold by the majority of the industry (Australian Bankers Association, Securities and Derivatives Industry Association, Investment and Financial Services Association Ltd).

Recommended option and conclusion

6.138 Cabinet is asked to agree to the two-staged implementation plan as described below, subject to the outcomes of a detailed consultation process.

6.139 The recommended approach achieves synergies with existing regimes (UCCC and FSR) thus reducing the regulatory burden as much as possible while at the same time achieving the Government's objectives.

Implementation and review

6.140 The phased approach proposed for development and implementation of the consumer credit regulatory framework (as described in the diagram above) will be subject to detailed consultation with relevant stakeholders. Consultation will be undertaken on the planned implementation process and throughout the development of draft legislation and could include:

•

officials from State and Territory Governments and ASIC;

•

a special group of key industry experts and consumer advocates; and

•

wider community consultation on draft legislation and specific areas such as the draft Finance Brokers Bill.

6.141 In addition, this RIS will be updated to assess the impacts and analyse the costs and benefits of the proposed preferred design of the various features.

Chapter 7 - Regulation impact statement - Commonwealth regulation of trustee companies

Problem

Background

Existing meaning of ' trustee company'

7.1 Prior to the passage of Commonwealth legislation to authorise trustee companies, a trustee company could be defined as a company which:

•

is registered under the Corporations Act 2001 (Corporations Act);

•

is authorised under one or more of the State and Territory Trustee Companies Acts; and

•

undertakes two broad types of work:

-

personal trustee and deceased estate administration work ('traditional activities');

-

broader financial services, such as funds management and acting as responsible entities of managed investment schemes.

The first of these areas of work is the focus of this regulation impact statement (RIS).

Overview of trustee companies industry

7.2 In the past, only a natural person could undertake the duties of a personal trustee in the sense of executor or administrator under a will (known as acting as a 'personal trustee'), owing to the fiduciary responsibilities of trustees for the trust assets and their personal liability in the event of any default. Moreover, it was generally not possible to establish a long term trust, such as a charitable trust.

7.3 To rectify this situation, the States and Territories passed legislation permitting private trustee companies to enter the market for personal trustee and estate administration work. At about the same time, the States and Territories also legislated to facilitate the establishment of long term and perpetual trusts, such as charitable trusts. They also created government-controlled Public Trustees ('public trust offices').

7.4 A trustee company that is authorised under one of the State/Territory Acts is typically regulated if it undertakes one or more of the following activities:

(a) Applies for probate, and/or acts as an executor or as administrator, of a deceased estate

7.5 Probate is a certificate granted by the Probate Division of the Supreme Court in each State and Territory that the will of a deceased person has been proved as valid and registered and that authority to administer the deceased estate has been granted to the executor providing or propounding the will.

7.6 An executor/administrator is the person nominated by a deceased person in their will to administer their estate upon their death. Trustee companies are able to act as executor of a deceased's estate when the time comes or arrange for the transfer of responsibilities, where an individual is nominated in a will as the estate executor and does not wish to take on the legal responsibilities entailed.

7.7 Non-authorised corporations are excluded from the market for the provision of trustee and executor services.

(b) Acts as trustee of a trust estate

7.8 Trusts can be set up for many purposes. For example, a settlor or testator can transfer property to a trustee to be held in trust for one or more beneficiaries. This can be useful, particularly when the beneficiaries are minors or unable to handle their own finances. Another example is the charitable trust or foundation, which may be established to help relieve poverty or advance educational, medical or religious purposes.

(c) Operates a common fund

7.9 Under the general law, trustees cannot mix the funds from two or more trusts. The State and Territory Acts override this restriction by allowing trustee companies to invest funds from more than one trust in a 'common fund', to enable the efficient pooling and investment of moneys from estates and trusts. In most States, external moneys may be accepted for investment into common funds - in such cases, the trustee companies must comply with the managed investment scheme provisions of the Corporations Act.

(d) Acts under a power of attorney

7.10 Under a power of attorney, a trustee company has authority to act for a person in relation to that person's legal or financial affairs.

(e) Other functions

7.11 Trustee companies also exercise other functions under State and Territory legislation. For example, a trustee company can act as a guardian for a minor or a disabled person. A guardian has legal custody of another person and his or her property when that person is unable to manage his or her own affairs.

7.12 Solicitors, accountants, financial advisers and Public Trustees are now the main competitors of private trustee companies in the market for 'traditional' services.

Broader financial services

7.13 Trustee companies have since expanded their activities into most areas of wealth creation, management and transfer. They now offer a range of financial services, including as the administrator for superannuation funds, as trustee for debenture and note issues and as the Responsible Entity for managed funds.

Market characteristics

7.14 The trustee company industry is relatively small with approximately ten licensed private trustee companies. The majority of these trustee companies are licensed and have operations in multiple jurisdictions. Some of the smaller markets and jurisdictions only have one licensed private trustee company providing these services. In some of the larger markets, such as New South Wales, Victoria and Queensland, there are seven to eight licensed trustee companies operating.

7.15 With the exception of one licensed trustee company - Plan B Trustees Limited (Plan B), based in Western Australia - all of the trustee companies and public trust offices are members of a single industry body, the Trustee Corporations Association of Australia (TCA).

7.16 According to TCA data for 2007, private trustee companies (excluding Plan B) have approximately $510 billion of assets under management. In aggregate, Public Trustees account for approximately $13 billion of the assets under management and a large proportion of these assets are under management in personal trusts. TCA member trustee companies and State Trustees Ltd manage approximately $20 billion of assets in personal trusts.

7.17 The bulk of trustee companies business is in the field of investment products. TCA member trustee companies and State Trustees Ltd have approximately $21 billion in assets under management in superannuation funds and $403 billion of assets under management in corporate activities, such as managed funds, securitisation programs and debenture and note issues^[4]. Based on these figures, in aggregate, personal trust business represents approximately 4 per cent of TCA member trustee companies' business^[5]. The industry generally refers to this part of their business as 'traditional activities'.

Current regulation of trustee companies

7.18 Trustee companies are currently required to be licensed and regulated under separate legislation in each State and Territory^[6] in which they operate. Corporations are unable to operate in a jurisdiction until the respective piece of legislation has been amended to include their business name as a trustee company under the relevant Act.

7.19 Commonwealth legislation will replace State and Territory legislation which:

•

authorise or license companies to provide traditional trustee company services generally (as opposed to laws that authorise or license companies to provide a particular traditional trustee company service);

•

regulate the fees that may be charged by companies for the provision of traditional trustee company services, and the disclosure of those fees;

•

deal with the provision of accounts by companies in relation to traditional trustee company services that they provide;

•

deal with the duties of officers or employees of companies that provide traditional trustee company services, in their capacity as officers or employees of those companies;

•

regulate the voting power that people may hold in companies that provide traditional trustee company services, or that otherwise impose restrictions on the ownership or control of companies that provide traditional trustee company services;

•

deal with what happens to assets and liabilities held by a company, in connection with the provision by the company of traditional trustee company services, if the company ceases to be licensed or authorised to provide such services. (There is an exception for complementary State and Territory laws that are needed to give effect to compulsory transfer determinations.)

7.20 The broader law relating to the obligations on trusts and trustees in each State and Territory^[7] will not be part of the proposed changes; however, those Acts may require amendment where necessary.

Other current regulation of trustee companies (outside of scope)

7.21 Where trustee companies engage in other activities, such as acting as a superannuation trustee, acting as a Responsible Entity for managed funds, providing a custodial or depository service, or acting as a trustee for debenture holders, they must comply with Commonwealth legislation, including the Superannuation Industry (Supervision) Act 1993, the Managed Investments Act 1998 and the Corporations Act 2001 (Corporations Act). These Acts regulate the activity being undertaken rather than the entity.

7.22 In order to undertake funds management activities, all of the private trustee companies hold Australian financial services licences (AFSLs). As a result, they are familiar with Australian Securities and Investments Commission (ASIC) regulation and the requirements of an AFSL. Equally, those trustee companies that act as superannuation trustees are Registrable Superannuation Entity licensees (RSEs) are familiar with Australian Prudential Regulation Authority (APRA) regulation - however, four^[8] trustee companies are not RSE licensees.

7.23 In addition to being subject to the respective trustee companies' legislation, trustee companies are subject to other State and Territory legislation when undertaking 'traditional activities'. For example, each State and Territory has a Trustee Act as well as legislation regarding wills, administration and probate. These legislative instruments, and associated common law, regulate particular activities and, as such, solicitors, accountants, financial advisers and trustee companies are subject to the requirements therein alike in providing such services.

7.24 Public trustees are subject to separate public trustee legislation in each of the jurisdictions rather than the legislation for private trustee companies. Except for State Trustees Ltd, which is a corporate entity owned by the Victorian Government, most of the Public Trustees are directly responsible to a State or Territory Government Department, such as the Department of the Attorney General or the Department of Justice, in the jurisdiction in which they operate. Since the Public Trustees are owned and operated by the respective State and Territory Governments, they do not have cross-border operations and nor do they have concerns about the compliance costs associated with seeking to operate nationally. That said, public trust offices that satisfy the criteria for licensing may opt to be bound by the legislation.

Regulatory need

7.25 The relevant State and Territory Trustee companies Acts amount to around 300 pages. This in itself is a significant burden. Moreover, the state Acts, as well as the common law relating to trusts, act to restrict competitive pressure and market discipline in the estate administration and trust management industry, particularly after the will or trust comes into effect. This market imperfection is the result of the trustee being appointed by someone other than the person(s) for whose benefit the assets will be managed by the trustee and the inability of the beneficiary to switch trustees, short of applying to the Supreme Court in cases of fraudulent conduct or administrative incompetence.

7.26 The beneficiary often has no contact with the trustee company prior to the will or trust coming into effect and after it does become operational, the beneficiary is generally unable to affect a change of the trustee company. While the main duty of a trustee is to administer the estate in accordance with the terms of the will or trust, regardless of the wishes of the beneficiary, once the will or trust comes into effect, it is the beneficiary that is ultimately interested in the proper and effective management of the estate. It is the beneficiary that bears the loss in the event of the mismanagement of the estate.

7.27 The Supreme Court is the only avenue of recourse for beneficiaries with concerns regarding the management of the trust or estate. In situations where the beneficiary has concerns relating to gross mismanagement or fraud, the Supreme Court can order that the trust assets be transferred to another trustee company. Court action is very costly and time consuming. Beneficiaries do not have access to alternative and more cost effective and timely dispute mechanisms.

7.28 Beneficiaries are exposed to significant costs/losses in the event that assets held on trust are inadequately managed by the trustee company. This concern is exacerbated by the ability of trustee companies to pool trust assets in common funds. Consumers are unlikely to be able to access the information on which to make informed decisions on how to manage this risk on their own. This applies to consumers when selecting a trustee company and it is also relevant to beneficiaries who have a legitimate interest in mitigating the risk of inadequate management of the assets held on trust for their benefit.

7.29 Generally, trustee companies consider testators/settlors to be their primary clients and only regard beneficiaries as (at best) 'secondary' clients. As a result, beneficiaries often are unable to access information on the terms agreed to by the testator/settlor. The inability of beneficiaries to readily switch trustees means that they cannot easily act on information about the management of the trust or estate. Beneficiaries should have access to sufficient information to be able to monitor the performance of the assets under management and the trustee company more generally. At a minimum, beneficiaries, or persons with a proper interest in the estate acting on their behalf, should be able to assess the performance of the trustee company in relation to the terms set out in the trust deed and to detect fraud or serious instances of administrative incompetence.

7.30 It is more difficult to ascertain the quality and service that will be provided by a trustee company rather than an individual because the personnel may change over time and it is unlikely to be clear which individuals will be performing the service or their level of expertise. This makes the procedures and risk management practices of the corporation itself important.

7.31 Trustee companies (private or public) are the only providers of estate management and personal trust services that can offer these services in perpetuity and, as such, may be viewed by individuals as having special expertise and reliability in undertaking personal trust and estate activity.

7.32 Government intervention or measures in addition to those directed at promoting competition are necessary to ensure adequate client protection for 'vulnerable' beneficiaries, such as the disabled, mentally impaired, elderly and minors, who may not have the capacity to adequately monitor their trustee's performance even if they were provided with the information to do so.

7.33 The prevalence of estate mismanagement and the extent of any resulting loss are currently not able to be quantified accurately due to the difficulty and expense of beneficiaries making a complaint. However, the concept of alternative dispute resolution is accepted by the majority of industry submissions on the Green Paper on Financial Services and Credit Reform (July 2008):

•

The TCA's submission stated that trustee companies are subject to a relatively low number of legitimate customer complaints, and that many complaints prove to be simply disputes between beneficiaries. Nonetheless the submission put forward a model for an appropriate external dispute resolution scheme (which would preserve the right to take a matter to the relevant Supreme Court).

•

Sandhurst Trustees' submission assumed the creation of a dispute resolution process, arguing that the trustee company needs to protect its reputation (including the right to take a matter to court) and should have the right to raise a matter directly with the dispute resolution body.

•

ANZ Trustees' and Equity Trustees Limited's submissions supported alternative dispute resolution.

•

Tasmanian Perpetual Trustees Limited (TPTL) submitted that there is no evidence of any systemic problems concerning the manner in which their traditional trustee business is being managed. However, TPTL has in place a form of internal dispute resolution, and it submits that any dispute which could not be resolved internally be required to be submitted to alternative dispute resolution.

•

Perpetual Limited submitted that the dispute resolution process should mirror the current Corporations Act regime.

•

Suncorp-Metway Ltd said: 'We agree that a more cost effective and timely External Dispute Resolution (EDR) mechanism for beneficiaries is necessary for personal trust assets. However, we would encourage this industry leveraging the existing EDR models under the newly converged Financial Ombudsman Schemes (FOS) rather than creating a new model.'

•

Trust Company Limited said: 'there is no better dispute resolution system than that offered by the Supreme Courts.'

•

Plan B agreed that consideration needs to be given to a suitable dispute resolution mechanism, which they believe should apply to all providers of trustee services.

7.34 Set out below is a table showing the number of complaints about members received by the TCA over the period 1995 to 2008. The figures cover matters that were deemed to be more than clarification of a trustee's role, such as a client unhappy with the trustee's service in terms of choice of investments, time taken to finalise administration of a deceased estate, or fees charged.

Table 1.1: Complaints received by TCA Secretariat

This does not include complaints that may have been made directly to a member of the relevant Attorney-General's Department/Consumer Affairs Office, or the subject of an approach to the relevant Supreme Court.

7.35 Notwithstanding the seemingly low number of complaints, 'traditional' trustee services are often provided to the most vulnerable of people (who in many cases would have difficulty asserting their rights), so it is conceivable that problems could be under-reported. Also, internal and external dispute resolution mechanisms are a common feature of financial products and services regulation under the Corporations Act.

7.36 The other main source of market failure in the financial system that normally warrants regulatory intervention is systemic risk. In relation to the management of trust and estate assets by trustee companies, as trustee companies are not part of the payments system and do not generally provide capital guaranteed funds or hold trust assets on their balance sheets, the level of systemic risk is very low. It is extremely unlikely that the failure of a trustee company would have any significant flow-on or contagion effects on the rest of the financial system or to the real economy more broadly.

7.37 The incidence of the failure of trustee companies is quite low. Since the early 1980s, only Trustees and Executors Agency Co Ltd (1983), and Burns Philip Trustee Company Ltd and its subsidiaries (1990-94) have been placed in liquidation.

7.38 One of the main outcomes of the Financial System Inquiry (Wallis Inquiry), which reported to the then Government in March 1997, was the broad acceptance of the importance of balancing financial safety regulation against efficiency and the importance of the level of intensity of financial regulation being in proportion to the risk of failure.

Current regulatory problem

7.39 Over the last decade, trustee companies have made a number of representations to all levels of government in relation to addressing the regulatory burden associated with the inconsistencies and duplicate licensing and reporting requirements in the State and Territory based regulatory framework. The variation in regulatory obligations imposed by the State and Territory governments can be seen in Table 1.1.

7.40 The Council of Australian Governments (COAG) agreed in July 2008, that the Commonwealth will assume responsibility for regulation of trustee companies. The scope of this RIS is to consider the options for a Commonwealth regulatory framework at an entity level. As noted previously, it is not within the scope of this RIS to consider other State, Territory or Commonwealth laws that apply to the various activities undertaken by trustee companies. The RIS considers the appropriate form and intensity of regulation required to achieve the objectives.

7.41 Business compliance costs and barriers to market entry are considered higher under the State and Territory based legislation than what is necessary to address the market failures. Overly prescriptive regulation on certain aspects of trustee companies operations in the State and Territory legislation were designed to address some of the market failures and to protect vulnerable consumers. These regulations cover: the ownership of trustee companies; fees (in most states there are fee caps); common funds; capital requirements; professional indemnity insurance; and directors' personal liability. The level and type of these restrictions varies between States and Territories. In some instances the law imposes quite restrictive rules, particularly in relation to prescribing fees and common fund operations. The current level of regulatory burden is not appropriately matched to the level of risk involved.

7.42 A key issue identified is that the current State and Territory licensing requirements restrict trustee companies from operating across borders. The need to obtain a licence in each individual State and Territory combined with the lack of transparency and consistency in licensing requirements creates barriers to entry and restricts competition in the marketplace. In addition, the State and Territory based licensing requirements create cost burdens for corporations that operate in more than one jurisdiction. These costs not only include the initial costs associated with obtaining licences in each jurisdiction that they wish to operate in, but also the ongoing compliance costs of meeting differing requirements, including reporting requirements, in different jurisdictions.

7.43 The current legislation is relatively antiquated and not consistent with other more modern financial sector regulation that was implemented on the basis of the Wallis Inquiry. The State and Territory based regulatory requirements are not nationally consistent and have a high level of prescription, which creates compliance and efficiency costs. Additionally, unlike licensing decisions made under Commonwealth licensing systems, the licensing arrangements for trustee companies involve political decision making rather than objective criteria. Additionally, in most jurisdictions the licensing decisions are not subject to administrative review. One industry participant has made a number of representations in relation to concerns about the restrictive nature and lack of transparency in the licensing process.

7.44 There are also concerns about the need for a more cost effective and timely alternative dispute resolution mechanism for beneficiaries to enhance the protections available for the trust assets.

7.45 There is some concern about the adequacy of current supervisory arrangements for trustee companies given the limited resourcing and expertise available for supervision in the individual jurisdictions. This is largely the result of a combination of factors, such as the small number of trustee companies in some the jurisdictions^[9] and the States and Territories referral of power for prudential regulation and client and investor protection to the Commonwealth in 1999. A single supervisor is expected to exploit economies of scale, reduce duplication, and over time, build up a greater level of expertise. This would increase the effectiveness and efficiency of supervision of trustee companies.

Objectives of Government action

7.46 Six objectives have been identified for a Commonwealth regulatory framework to address the problems identified earlier. Options for reform will be evaluated against these objectives in the next section. The objectives are:

•

Objective 1 - Enable approved corporations to operate as trustee companies and license them under Chapter 7 of the Corporations Act;

•

Objective 2 - Ensure effective management and safeguarding of trust assets;

•

Objective 3 - Ensure appropriate disclosure to clients about the type of services and products being offered by the trustee company;

•

Objective 4 - Provide for lower cost dispute resolution, to enable beneficiaries to address issues of underperformance or incompetence and/or replace an underperforming trustee in a cost effective way, in cases where alternative dispute resolution is a viable alternative to the courts;

•

Objective 5 - Modernise the regulation of trustee companies and have any regulation apply on a national basis in accordance with Recommendation 90 of the Wallis Review and the Government's policy regarding reducing regulatory burden more broadly; and

•

Objective 6 - Facilitate a competitive national market for trustee companies through:

-

reducing barriers to competition and competitive neutrality issues;

-

reducing business compliance costs and improve efficiency of operations; and

-

promoting efficient pricing of services provided by trustee companies.

Options that may achieve objectives(s)

7.47 Three options have been identified which would address the objectives of a Commonwealth regulatory framework:

•

Option 1: Status quo - no additional Commonwealth regulation;

•

Option 2: Consumer protection and disclosure regulation with supervision by ASIC; and

•

Option 3: Prudential regulation with supervision by APRA.

7.48 Under each option, consideration is given to whether that option addresses the identified market failures and meets the above objectives.

7.49 In examining the options, it was considered important to take account of the rationale for how financial services are regulated to ensure that the level and type of regulation recommended not only addresses the market failures identified, but is balanced against efficiency considerations and is consistent with the broader approach to financial sector regulation in Australia.

Option 1: Status Quo

7.50 Trustee companies will remain able to act as trustees, executors and administrators under State and Territory laws, with powers and duties similar to those of natural persons.

7.51 Trustee companies will not be under any regulatory obligation to disclose information about the potential performance of any investment of funds under the trust. However, this type of disclosure may occur through the discussions between the testator and trustee company at the time of creation of the trust instrument.

7.52 This option would fail to deliver on the COAG commitment and would not assist beneficiaries to address issues of underperformance or incompetence and/or replace an underperforming trustee in a cost effective way. Beneficiaries will retain the ability to remove trustees where there is gross mismanagement or fraud in relation to trust assets. There will be no provision for lower cost dispute resolution to enable beneficiaries to address issues of underperformance or incompetence and/or replace an underperforming trustee in a cost effective way.

7.53 This option will retain the stratified State and Territory based regulatory system and will fail to address the current regulatory burden faced by trustee companies wishing to operate across more than one jurisdiction. Business will continue to report to each State and Territory body in which it operates, as well as ASIC under the corporation's AFSL obligations and APRA if the corporation is an RSE licensee. It will also retain regulation that is unnecessarily burdensome on a potential new entrant for addressing the market failures and risks identified.

7.54 Potential new entrants will only be allowed entry into the market if they can gain acceptance from the relevant minister in each jurisdiction. Trustee companies are only able to undertake traditional activities in a State or Territory where the name of that corporation has been added to the relevant trustee company act. The relevant jurisdiction may provide guidelines which the Government will use to determine the application for entry; however where these guidelines are available they may be highly subjective and open to political considerations. These barriers to entry will remain high.

7.55 This option will not address Objective 6, as it will not provide for a reduction in business compliance costs and will not improve the efficiency of the market operators. The fees and charges caps will continue to apply in most jurisdictions, as will: personal director's liability; restrictions on ownership; requirements on a certain number of directors to reside within the jurisdiction; and opening hours will continue to be regulated in the Northern Territory. Furthermore, it will fail to address Objective 4 as it will not allow for easier removal of trustees in cases of poor trustee performance. It will therefore fail to facilitate a more competitive market.

Option 2: Consumer protection and disclosure regulation with supervision by ASIC

7.56 In the Commonwealth regulatory framework, consumer protection and disclosure regulation is implemented by the ASIC. Consumer protection and disclosure regulation implemented by ASIC is aimed at protecting the interests of consumers of a wide range of financial services and products. It seeks to ensure that the activities of financial service providers are subject to scrutiny and accountability to the regulator for the purpose of consumer protection.

7.57 Under this option, the States and Territories would repeal their Trustee Companies Acts. The Commonwealth has the power to regulate trustee companies at an entity level, for the purposes of licensing and ongoing supervision, under various powers, including section 51 (xx), of the Constitution. Under this option, there are two different approaches that could be taken to regulate trustee companies under the Corporations Act. The Corporations Act could be amended to provide for:

•

A stand alone chapter for entity level regulation of trustee companies and a licensing mechanism; or

•

A separate chapter for entity level regulation of trustee companies with the licensing mechanism linked to the AFSL regime and the integration of the provision of estate administration and personal trustee management services by trustee companies into the financial services regime (Chapter 7 of the Corporations Act). This would involve defining the provision of these services as the provision of a financial service.

7.58 Under both options, a chapter conceptually similar to Chapter 5C (Managed investment schemes) could be added to the Corporations Act for the entity level regulation for trustee companies. This chapter could be included as 'Chapter 5D Trustee Companies'.

7.59 Some of the means that would be used in a client protection regime in order to address Objective 2 of ensuring effective management and safeguarding of trust assets are:

•

the requirement that a trustee company be a public company or a wholly owned subsidiary of a public company;

•

the requirement that the corporation holds an AFSL that covers the provision of traditional trustee company services - ASIC monitors applications for licences, enforces licence conditions and varies, suspends or cancels licences;

•

provisions that allow trustee companies to pool the money from different estates in common funds. These provisions will also allow external investment into the common funds, but where there is external investment the trustee company will have to comply with Chapter 5C of the Corporations Act. The provisions on common funds will set out a number of general rules for the operation of common funds;

•

provisions setting out restrictions to the fees and charges that can be charged by trustee companies in relation to the provision of personal trust and estate administration services. The provisions on fees may also include requirements relating to whether the fees can be taken from capital or income, or a combination of the two;

•

in relation to charitable trusts, 'grandfathering' of fees charged to existing clients, and capping of fees charged to new clients, with a review of these arrangements after two years;

•

deregulation of the fees charged to all other trusts and estates, subject to a requirement that the company's fee schedule be disclosed on the Internet and a requirement that corporations charge no more than the fees specified in their published fee schedule at the time they begin administration;

•

appropriate disclosure obligations, including provision for electronic disclosure;

•

a 15 per cent limit on any one person (and associates) holding voting shares in a trustee company, combined with a compulsory divestment regime to deal with breaches, and a provision allowing Ministerial consent for share acquisitions in trustee companies above the threshold;

•

alignment of directors' and employees' liability with the Corporations Act;

•

requirements for adequate financial resources;

•

requirements for a specified level of professional indemnity insurance to support compensation arrangements for the clients of trustee companies;

•

winding up provisions;

•

reporting obligations;

•

enforcement powers and ability to revoke the licence;

•

internal and external dispute resolution provisions, and

•

repeal of overlapping/inconsistent State/Territory laws.

7.60 The 'traditional' operations of trustee companies are likely to be new ground for ASIC. Although some pre-existing expertise will be relevant, significant effort would be required in terms of both developing the regulator's expertise and the standards that they would administer.

7.61 The client protection regime discussed above would directly address Objective 2 as it would ensure there are protection arrangements in place aimed at reducing the risk of inadequate management by the trustee company. It will address Objective 3 through ensuring there is adequate disclosure of information by the trustee company to the testator/settlor (and beneficiary where appropriate) in order to understand the service being offered by the corporation.

7.62 Unlike a prudential regime, a client protection regime is directly focused on the protection of assets held on trust for the beneficiary and hence more directly addresses the market failures identified. Because it is not specifically focused on the corporate health of the entity itself (except to the extent that it impacts on the management of off-balance sheet trust assets) it does not specifically seek to prevent the failure of the trustee company itself. In the event of a failure of a trustee company, common law, trust law and the relevant State or Territory Supreme Court would provide for the protection of trust assets and the mechanism for the transfer of the trust assets to another trustee.

7.63 In relation to Objective 4, it is proposed that clients would have access to an alternative dispute resolution mechanism. This could be an existing scheme such as the Financial Ombudsman Service or alternatively, a new industry-funded alternative dispute resolution body could be established.

7.64 This option would also provide for the authorisation of trustee companies (Objective 1), as well as being consistent with the Wallis recommendation referred to in Objective 5.

7.65 In relation to Objective 5, it is clear that any form of Commonwealth legislation would create a national market by creating a single approval and supervisory regime and eliminate unnecessary compliance costs and barriers to competition caused by duplication or inconsistencies in the State and Territory based requirements.

Option 3: Prudential regulation with supervision by the Australian Prudential Regulation Authority

7.66 In the Commonwealth regulatory framework, prudential regulation is implemented by APRA. Prudential regulation is generally aimed at protecting the prudential health of systemically important financial institutions, primarily for the maintenance of system stability. Prudential regulation is applied to a narrow range of financial institutions, whereas consumer protection regulation is aimed at protecting the interest of consumers in relation to the activities of financial service providers. Prudential regulation is a significant intervention into a market and implies a regulatory intensity significantly greater than that under the status quo or of client protection regulation.

7.67 Under this option, the Commonwealth would implement legislation along the lines of a 'trustee companies prudential supervision act' to provide for licensing arrangements and ongoing prudential supervision by APRA. The Commonwealth would also need to amend legislation for the purpose of levying trustee companies to fund the cost of supervision. The levy would be based on the asset pools managed by trustee companies, similar to the way in which levies are applied to other prudentially regulated entities.

7.68 Under a prudential regime, it would be the role of APRA to put in place appropriate prudential standards under the legislative framework. APRA's standards would likely cover the following:

•

fit and proper requirements for directors and senior management;

•

risk management systems;

•

outsourcing;

•

adequacy of resources; and

•

capital requirements - net tangible assets.

7.69 It is worth noting that the development of a prudential regime for trustee companies would take significant time and resources to set up since there has not previously been prudential oversight of trustee companies (at either the State or Commonwealth levels of government) and APRA does not have experience in the non-financial operations of trustee companies.

7.70 A prudential regulatory regime would aim to address Objective 2 by providing for third party oversight (for example, auditor oversight) of the management processes of trustee companies. A prudential regime would not focus on empowering clients to enforce their rights in the same way that a client protection regime would. APRA would not be involved in the day-to-day interactions of trustee companies and their clients and would not undertake the role of dealing with consumer complaints.

7.71 Prudential regulation provides for intense oversight of the risk management systems and policies of the regulated entities. Standards under a prudential regime are generally more prescriptive and intrusive. This oversight is more intense than in a client protection regime as it is directed at the health of the entity itself, as distinct from directly focusing on the entity's capacity and resources to effectively manage trust assets for beneficiaries. Similarly, licensing requirements of a prudential regime may be more intense than under a client protection regime.

7.72 A key objective outlined for the regulation of trustee companies is that there are adequate protection arrangements in place regarding the quality of management of trust estates administered by trustee companies in order to protect the interests and assets of beneficiaries. While prudential supervision would provide for relatively intense scrutiny of trustee companies, given its focus, it may not provide as many protections for beneficiaries and testators in relation to Objective 2 compared to a regime focused on client protection.

7.73 Commonwealth legislation could authorise trustee companies as per Objective 1. As noted above in relation to Objective 5, any form of Commonwealth legislation would create a national market and eliminate the unnecessary compliance costs and barriers to competition caused by duplication or inconsistencies in State and Territory based requirements.

7.74 This option would address Objective 6, however in a less satisfactory manner than Option 2 as the compliance costs, barriers to competition and the competitive neutrality issues associated with prudential regulation would be significantly greater than for a client protection regime. These costs are primarily associated with the increased regulatory intensity of a prudential regime. In addition, trustee companies would also be expected to cover the costs associated with the role of the prudential regulator itself, which would be passed on to industry through levies. Such costs would include a significant start-up cost for developing the prudential standards and significant ongoing costs. Likewise, given there would continue to be licensing requirements, which are likely to be more difficult to satisfy than under a client protection regime, there would be some barriers to competition. However, improvements in the licensing processes compared to the existing systems, including improved transparency, are expected to provide reductions in other barriers to competition.

7.75 The significant costs identified would need to be weighed against the benefits, which as already noted, may not match the benefits desired as effectively as a client protection regime. It should also be noted that as lawyers and other individuals who offer personal trust services are not subject to prudential oversight, the imposition of significant compliance costs would have implications for competitive neutrality. It has also been noted that most of trustee companies' business is now in the field of funds management rather than 'traditional activities'. Since there is no prudential oversight of other Responsible Entities for managed funds, there would also be a significant competitive neutrality issues if trustee companies were prudentially regulated at an entity level.

7.76 In regard to Objective 4, it has been noted that the Commonwealth prudential regulator does not handle disputes or have experience in dealing with client protection issues. The dispute handling procedures proposed under Option 2 above (the use of an existing complaints scheme to hear all complaints or a new industry-funded body) could be put in place separate from the prudential regime.

7.77 In relation to Objective 5, Commonwealth prudential legislation could provide for a modern, uniform national regime, in accordance with the Wallis Inquiry recommendation, which would remove some of the current administrative burdens. However, a prudential regime may create other unnecessary burdens on business, which would not be consistent with best practice regulation in relation to minimising the regulatory burden.

Table 1.2: Comparison of current State and Territory regulatory obligations and Commonwealth proposals

Impact analysis

7.78 When considering the form of regulation that should be introduced by the Commonwealth, it is important to consider the compliance costs and implications for competitive neutrality.

7.79 The change from State and Territory regulation to Commonwealth regulation will affect the private trustee companies that are currently licensed to operate in each State and Territory and State Trustees Limited, the Victorian public trustee (11 trustee companies in total). Other groups that may be affected are settlors/testators and beneficiaries, including charities which are recipients for charitable trusts, and 'vulnerable' beneficiaries including the disabled, minors, family beneficiaries and mentally impaired people. Competitors to trustee companies in the traditional business activities (public trustees, lawyers, accounting firms etc) also have the potential to be affected by these changes. State and Territory governments and the Commonwealth regulator, either ASIC or APRA, will also be affected by these changes.

7.80 The new compliance costs of either option needs to be compared against the compliance costs trustee companies currently face under Option I. In October 2007, ANZ Trustees Limited provided compliance cost data to the Commonwealth Attorney-General's Department. Under the existing State and Territory legislation, ANZ Trustees' compliance costs are $1,749,000 per annum. They estimated that approximately 20 per cent of the compliance costs could be attributed to the differences in legislation and duplication of reporting requirements. Therefore the move to Commonwealth regulation has the potential to save trustee companies approximately 20 per cent in compliance costs.

Option 1: Status Quo

7.81 The adoption of this option will obviously have the least impact on the market for estate administration and trust management. As this option will not achieve a national licensing scheme, there will be no improvements in the licensing processes.

7.82 The costs for Option 1 can be broken into three main elements:

•

start up/ transitional costs;

•

ongoing compliance costs; and

•

ongoing supervision costs.

Start up / transitional costs

7.83 The retention of the State and Territory entity level regulation of trustee companies will have no transitional cost implications for the market participants. Trustee companies have developed their business models with the current regulatory framework in mind, and will be able to continue to function under this option.

7.84 New market entrants in any jurisdiction will continue to face high start up costs due to the subjective nature of the stated authorisation guidelines (if any) which take into account political considerations. The lack of transparency around this process ensures high costs to potential entrants who are unable to effectively determine if they may be licensed or not.

7.85 Each separate State and Territory government will retain the power, and commensurate cost liability, for the licensing of new market entrants. The South Australian Office of Consumer and Business Affairs have quantified the cost for the licensing process for each new application for entry at between $7,000 and $10,000.

Ongoing compliance costs

7.86 Trustee companies that maintain a market presence in more than one jurisdiction/market will continue to face high compliance costs attributable to the differences in legislation and duplication of reporting requirements. As stated above, ANZ Trustees have estimated that approximately 20 per cent of its $1.749 million compliance costs could be attributed to these differences.

Ongoing supervision costs

7.87 Each separate State and Territory will continue to incur negligible costs for the regulation of these corporations. Ongoing regulatory oversight by the States and Territories consists of the review of the submitted quarterly, biannual or annual reports. The cost of this has been quantified as one policy officer working on these issues for one day per annum. This task has been outsourced by the New South Wales government to a consultant with the cost charged back to the trustee company. The Western Australian government charges a fee to the trustee companies in its jurisdiction that cover any cost of supervision.

Benefits for trustee companies

7.88 This option will have no transitional costs for market participants in contrast to the alternative options. Trustee companies will retain their current level of market power in each separate market, as the high barriers to entry will remain. Current market participants will continue to be subject to a low level of ongoing regulatory scrutiny.

7.89 Affected parties will retain the option of action against a trustee company where there is fraud or gross mismanagement of trust assets. However, affected parties will remain devoid of alternatives to the Supreme Court where the trustee is performing poorly, though not fraudulently.

Benefits for consumers

7.90 In jurisdictions other than Western Australia and the Australian Capital Territory, the fees able to be charged by trustee companies will continue to be capped. This will provide a default position that will provide a level of certainty to consumers at risk of being more severely overcharged for these services. However, it should be noted that consumers in all jurisdictions are able to negotiate for either higher or lower fees than the capped amount. The default benefit that a fee cap provides to consumers is expected to be of less value than the deregulated approach, with increased national competition, proposed under Option 2.

7.91 Trustee companies will continue to be required to provide a low level of disclosure to settlors/testators as provided for by the common law. This disclosure will not be as effective or beneficial to settlors/testators as that proposed under Option 2.

Option 2: Consumer protection model administered by ASIC

7.92 This is the Government's preferred option. It would provide that the traditional functions of trustee companies (administering charitable and other trusts, obtaining probate, acting as the executor of a deceased estate or under power of attorney) are deemed to be financial services for the purposes of the Corporations Act. It is intended that both settlors/testators and beneficiaries would be 'retail clients' of trustee companies for the purposes of section 761G of the Corporations Act.

7.93 It would also provide that authorised trustee companies are:

•

required to be an Australian registered public company or a wholly owned subsidiary of a public company;

•

regulated by ASIC;

•

required to hold an AFSL with an appropriate authorisation to carry out 'traditional' trustee companies services;

•

subject to the consumer protection, licensing and conduct requirements of the Corporations Act and the ASIC Act;

•

to the extent appropriate, subject to the disclosure requirements of the Corporations Act;

•

(unlike under the State/Territory model) required to have suitable internal and external dispute resolution arrangements;

•

in relation to charitable trusts, subject to fee regulation, in the form of 'grandfathering' of fees charged to existing clients, and capping of fees charged to new clients, with a review of these arrangements after two years;

•

in relation to non-charitable trusts and estates, subject to deregulation of the fees they can charge, subject to a requirement that the company's fee schedule be disclosed on the Internet and that corporations charge no more than the fees specified in their published fee schedule at the time they begin administration of the trust/estate;

•

subject to director and employee liability arrangements that are consistent with the obligations in place for other corporations under the Corporations Act;

•

subject to a $5 million capital adequacy requirement;

•

subject to a cap of 15 per cent on the shareholding of any single shareholder and associates, together with a divestment regime and a Ministerial discretion to consent to share acquisitions above the cap (for example, for wholly owned subsidiaries); and

•

permitted to hold common funds, which are able to continue to attract external investment.

7.94 While there will be compliance costs associated with a client protection regime, for example reporting requirements and requirements for financial resources, these would be considered to be relatively minimal, especially when compared to those associated with a prudential regime (see Option 3). Likewise, given there would still be authorisation/licensing requirements, some restrictions to entry and barriers to competition would remain. However, the creation of a national licensing scheme and the other improvements in the licensing processes, including objective criteria and improved transparency, is expected to minimise such costs.

7.95 The costs for Option 2 can be broken into three main elements:

•

start up/ transitional costs;

•

ongoing compliance costs; and

•

ongoing supervision costs.

Start up / transitional costs

7.96 Under Option 2, trustee companies will have to either apply to ASIC for a trustee company licence or apply to ASIC for a modification of their AFSL. The current cost to modify AFSL conditions is $230 for an online application and $270 for a paper application. The cost of a separate trustee company licence is likely to be similar to the cost of an AFSL. The current cost to apply for a corporate AFSL is $270 for an online application or $540 for a paper application^[11]. Therefore, it is estimated that the total maximum cost for applications for trustee company licence would be approximately 11*$540 = $5,940.

7.97 Current market participants will be required to apply for an alteration to their current AFSL to include the ability to act as an authorised trustee company. Trustee companies may incur implicit costs in order to comply with the ASIC licensing conditions, such as meeting adequate financial resources and professional indemnity insurance requirements. While the exact costs cannot be quantified, it is expected that the costs will not be significant as most trustee companies already meet most of these requirements as part of their compliance with AFSL requirements and complying with APRA requirements to act as a superannuation trustee.

7.98 New entrants may incur significant costs to gain an AFSL, however this cost is expected to be lower than the entry cost under Option 1 as the licensing requirements are certain; are not subject to the same political considerations; and will provide national access.

7.99 The Commonwealth Government will incur the cost of ASIC developing and implementing the new trustee company licence. As noted previously, the non-financial operations of trustee companies are new ground for ASIC. This means that although some pre-existing expertise will be relevant, significant effort would be required to develop the regulator's expertise in this area. This implies that there would be significant set-up costs and time taken for implementing this regime. ASIC has provided an estimate of $2.2 million across the first four years of new Commonwealth regulation.

Ongoing compliance costs

7.100 Trustee companies will incur significant costs to comply with the reporting requirements and to maintain their compliance frameworks. However, trustee companies currently incur significant costs to comply with the State and Territory regimes. The Commonwealth regime will streamline most of the trustee companies' reporting and compliance requirements, thereby reducing the overall regulatory burden and compliance cost of trustee companies that operate in more than one jurisdiction. However, the consumer protection regime is likely to be more intense than that currently applying to trustee companies under the State and Territory regimes. So overall there is likely to be minimal net change to trustee companies' compliance costs from the status quo.

7.101 Trustee companies will be required to have appropriate internal dispute resolution mechanisms and to be a member of an ASIC approved external dispute resolution (EDR) Scheme. The EDR Scheme will either be a new scheme set up specifically for the 'traditional activities', or will be an existing scheme that can extend its coverage to include the 'traditional activities'. The scheme will be industry funded, with the costs likely to be covered by membership fees.

7.102 It is difficult to estimate the exact cost of the scheme, as this will depend on the number of complaints received. Membership fees for the former Financial Industry Complaints Service (FICS), now the Investments, Life Insurance and Superannuation division of the Financial Ombudsman Service can be used as a guide. In October 2007, Public Trustee NSW advised the Commonwealth Attorney-General's department its annual cost of membership to FICS was $5,735. Therefore, it is estimated that the total maximum cost for EDR Scheme for trustee companies would be approximately 11*$5,735 = $63,085 per year.

7.103 Trustee companies will be required to submit an annual audited financial statement to ASIC. As part of this process, the licensee must lodge an auditor's report with ASIC demonstrating that they continue to meet their obligations under their AFSL.

Ongoing supervision costs

7.104 The Commonwealth Government will incur ongoing costs for ASIC to supervise trustee companies. ASIC has provided an estimate for their ongoing supervision costs of $1 million per annum.

7.105 ASIC will have the power to conduct surveillance visits on trustee companies to ensure that the corporation continues to fulfil it's obligations under the AFSL.

Benefits for trustee companies

7.106 Trustee companies will benefit from streamlined reporting requirements and only answering to one supervisor for 'traditional activities'. The national regulatory requirements will reduce the complexity of each trustee companies' compliance monitoring arrangements and make compliance training easier and less complex. This will reduce the trustee companies' risk of a compliance breach. Trustee companies that are not currently licensed in each State and Territory will benefit from a national licensing scheme, which will allow them to potential grow their operations.

7.107 Industry claim they will be disadvantaged by the consumer protection requirements, as their main competitors will not have to comply with them. However, trustee companies already comply with the complex State and Territory requirements and the AFSL requirements. The trustee company licence requirements will not be significantly different from the AFSL requirements and will be more streamlined than the status quo. In addition, the consumer protection measures will be a selling point to new clients as their competitors do not offer these additional protections.

7.108 Directors of trustee companies will not be subject to personal liability where they satisfy the relevant provisions of the Corporations Act. In particular:

•

Under Chapter 2M, subsection 180(1), a director or other officer of a company must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise, taking into account the particular circumstances of the corporation and the office and responsibilities of the officer.

•

Under subsection 180(2), the so-called statutory 'business judgment' rule, a director or other officer of a corporation who makes a business judgment is taken to meet the requirements of the statutory duty of care and diligence in subsection 180(1), and the equivalent duties at common law and in equity, in respect of the judgment if they satisfy certain criteria.

•

Under section 197, a person who is a director of a company when it incurs a liability while acting, or purporting to act, as a trustee, is liable to discharge the whole or part of the liability if the company:

-

has not, and cannot, discharge the liability or that part of it; and

-

is not entitled to be fully indemnified against the liability out of trust assets solely because of one or more specified circumstances.

•

In addition, the duties of officers and employees of registered schemes (see sections 601FD and 601FE) should be extended to apply to officers and employees of trustee companies to ensure appropriate fiduciary duties are owed.

7.109 This will bring the obligations on these directors in line with other parts of their businesses.

7.110 Consistent with the application of the AFS licensing regime, there should be a direct obligation on trustee companies to have adequate compensation arrangements.

Benefits for consumers

7.111 The creation of a national market is likely to increase competition in the 'traditional services' market. Consumers will benefit from this through improved service, possible reduction in price, and possibly new products. Consumers will also benefit from enhanced consumer protection, which include disclosure requirements and an external dispute resolution scheme. This will enable beneficiaries to better monitor how the trust assets are managed and give beneficiaries an avenue to have their complaints addressed that is not available to them under the status quo. This option will attempt to overcome some of the current common law barriers to competition by assisting consumers to better overcome the information asymmetry present in the status quo and allow for easier movement of estates among trustee companies.

7.112 In contrast to the status quo, the introduction of an ASIC licensing regime to these entities will minimise the risk of ineffective management of trust assets as trustee companies will be required to ensure that each corporation can:

•

demonstrate organisational competence (competence of responsible managers) to provide trustee services;

•

ensure representatives of these corporations are competent and adequately trained to provide those services; and

•

ensure that the business has adequate technological and human resources in place to comply with their legal obligations.

These measures will also address the risk to the consumer of being unable to determine what the quality of personnel may be at the point of the execution of the estate.

7.113 In respect of the grandfathering of the fees charged to charitable trusts that are existing clients, it is expected that this will benefit the trusts because they will not have to deal with sudden increases in fees resulting from the new regime. While there may be some detriment to the corporations because they may be unable to change their fees to reflect their costs, the grandfathering will be reviewed after two years. In respect of the capping of the fees charged to charitable trusts that are new clients, again this should benefit the clients as their fees will be similar to the mid range charged in the States and Territories, while equally any detriment to the corporations will be a factor in the review to take place after two years.

7.114 In respect of the deregulation of fees charged to all other trusts and estates, trustee companies may be more likely to take on trusts that previously would have been completely unprofitable due to fee caps. It is expected that this will lead to increased competition, but also better service as corporations are able to price fee structures in a manner that provides an incentive for increased performance. Any detriment to clients will be mitigated by the requirement that fees cannot be any higher than those set out in the published fee schedule at the time the estate is committed for administration.

7.115 It is considered that, on balance, the 15 per cent limit on any one person (and associates) holding voting shares in a trustee company will benefit clients and not lead to any greater burden on trustee companies. The disadvantages of ownership limits are that they can lead to companies being unduly restricted in raising further capital, and they can also have the effect of insulating management from normal competitive pressures. The benefit of ownership restrictions is that they ensure a broad spread of shareholdings, protecting the corporation from the adverse circumstances of major shareholders. The legislative restrictions on the acquisition of voting shares in trustee companies which apply in some jurisdictions are shown below in Table 1.3. There is no trustee company at present which would breach the 15 per cent maximum equity holding.

Table 1.3: Ownership restrictions

7.116 The 15 per cent limit aligns with a similar requirement for 'financial sector companies' under the Financial Sector (Shareholdings) Act 1998 (which includes any authorised deposit-taking institution as defined in the Banking Act 1959, or a holding company of such a company). It also aligns with a 15 per cent limit under Division 1 of Part 7.4 of the Corporations Act on bodies corporate, together with their holding companies, that hold an Australian market licence or an Australian clearing and settlement licence, and that is considered to be of national significance to Australia. Such a body is known as a 'widely held market body'. The most important example is the Australian Securities Exchange (ASX).

7.117 Generally, Ministerial consent is required for share acquisitions in trustee companies above the threshold limit. However, consent is frequently given, and many trustee companies are subsidiaries of other financial institutions, without apparent detriment to personal trust work.

7.118 The compulsory divestment regime to deal with breaches is expected to be required infrequently, and will require some resources to administer on the part of ASIC.

7.119 It is expected that the increased consumer protection measures, disclosure requirements and access to EDR will have an indirect, but positive impact on families.

Option 3: Prudential regulation administered by APRA

7.120 While a prudential regulatory regime would create a national market and eliminate the unnecessary compliance costs and barriers to competition resulting from the State and Territory based regimes, the compliance costs and the competitive neutrality issues associated with prudential regulation would be significantly greater than for a consumer protection and disclosure regime.

7.121 Prudential regulation of trustee companies raises significant competitive neutrality issues because the main competitors of trustee companies in the personal trust and estate administration market, such as public trustees, lawyers, and accountants, are not subject to prudential regulation. Prudential regulation of trustee companies at entity level would also have competitive neutrality implications in relation to their main competitors in the funds management business and their other main corporate activities, which are not subject to prudential regulation.

7.122 The costs for Option 3 can also be broken into three elements:

•

start up/transitional costs;

•

ongoing compliance costs; and

•

ongoing supervision costs.

Start up / transitional costs

7.123 Under Option 3, trustee companies would have to apply to APRA for a trustee company licence. As discussed previously, this licence is likely to be based on the Superannuation trustee scheme and is likely to have similar costs. The current APRA licensing fee is $68,200. Therefore, it is estimated that the total maximum cost for applications for a trustee company licence would be approximately 11*$68,200 = $750,200.

7.124 There would be various other implicit costs for trustee companies to comply with the prudential standards as specified by APRA. It is envisioned that the prudential standards would be similar to those applying to superannuation trustees. These include risk management, adequacy of resources, capital adequacy requirements, governance, and fit and proper criteria. While the exact costs cannot be quantified, it is expected that the costs will not be significant for trustee companies that are already RSE licensees. Seven trustee companies currently hold RSE licenses; however for trustee companies that do not hold RSE licenses, there could be significant costs to meet the prudential standards.

7.125 At a future date APRA may introduce other prudential standards affecting the operations of trustee companies. Additional prudential standards would be subject to a new RIS process. Prudential standards made by APRA are legislative instruments and are therefore subject to parliamentary scrutiny.

7.126 As noted previously, the non-financial operations of trustee companies would be new ground for APRA. This means that although some pre-existing expertise will be relevant, significant effort would be required to develop the regulator's expertise in this area. This implies that there would be significant set-up costs and time taken for implementing this regime. APRA estimates that it would cost approximately $750,000 to develop and implement the new trustee company licence regime. This cost would be borne by industry and collected through the annual levy process in the first year of APRA supervision.

Ongoing compliance costs

7.127 Trustee companies would incur significant costs to comply with the reporting requirements and to maintain their compliance framework. However, trustee companies currently incur significant costs to comply with the State and Territory regimes. The Commonwealth regime would streamline most of the trustee companies reporting and compliance requirements, thereby reducing the overall regulatory burden and compliance costs of trustee companies that operate in more than one jurisdiction.

7.128 However, the prudential regulation would be significantly more intense than the status quo. Overall there is likely to be a net increase in trustee companies' compliance costs from the status quo. This is because the prudential regulation regime of trustee companies would be based on the prudential standards applying to superannuation trustees. These standards are more onerous in relation to the financial affairs and management of the corporation than the status quo. For example, persons of responsibility in trustee companies, such as directors, senior management and accountants, do not have to satisfy 'fit and proper' requirements under the status quo, except when applying for a licence in Queensland. Trustee companies also do not have to comply with external risk management standards or are required to have detailed risk management strategies under the status quo. Both 'fit and proper' and risk management requirements would be part of the prudential standards that trustee companies would have to satisfy when applying for a licence and on an ongoing basis under prudential supervision by APRA.

7.129 Ongoing prudential supervision would also be more intense on trustee companies than the current supervision by States and Territories. Prudential supervision would involve regular on-site inspections by APRA, supported by investigation and enforcement powers, while the status quo does not.

Ongoing supervision costs

7.130 There would be ongoing costs for APRA to supervise trustee companies and administrate the licensing scheme. APRA estimates their ongoing costs in relation to trustee companies would be between $1 million and $1.5 million per year. APRA costs would be met by the trustee companies through industry levies. The levies could be calculated and collected using the same mechanism currently used for other financial sector levies.

Benefits for trustee companies

7.131 Similar to Option 2, trustee companies would benefit from streamlined reporting requirements and only answering to one supervisor for 'traditional activities'. However, prudential regulation and supervision is likely to be more intense than the current regulation and supervision trustee companies comply with. This is likely to offset any benefit trustee companies receive from national, streamlined regulation. Therefore, Option 3 is likely to increase the overall regulatory burden on trustee companies.

7.132 Trustee companies that are not currently licensed in each State and Territory would benefit from a national licensing scheme, which would allow them to potentially grow their operations without increased regulatory cost. However, given the intense prudential standards attached to the licensing under APRA, some trustee companies that are currently State/Territory licensed may not be granted/retain their licence under this option.

7.133 Given the prudential standards would establish more detailed requirements than the status quo, including in relation to matters that are not currently subject to regulation by most states and Territories, there is no guarantee that all the trustee companies would be able to comply with these standards. Before granting/ renewing trustee company licenses, APRA would have to undertake a thorough assessment of each trustee company's operations and the fitness and propriety of their responsible persons to ensure the corporations meet all the prudential standards.

Benefits for consumers

7.134 The creation of a national market is likely to increase competition in the 'traditional services' market. Consumers will benefit from this through improved service, possible reduction in price, and possibly new products.

7.135 In contrast to Option 2, this option would not address the problem of ineffective management and safeguarding of trust assets. This option would also fail to assist consumers to gain greater disclosure of the products and services that a trustee company may be providing. However, consumers can be more confident that the business in which they are contracting as trustee would remain viable as an entity. Consumers under this option would also gain from an increased regulatory focus on risk management systems.

Consultation

7.136 The main consultation document for the Commonwealth regulation of trustee companies is the Financial Services and Credit Reform Green Paper, which was released on 3 June 2008. Over 15 written submissions were received in response to the Green Paper in relation to the Commonwealth regulation of trustee companies. A list of the entities that provided those submissions is as follows:

•

ANZ Trustees Limited;

•

Australasian Compliance Institute;

•

Australian Wealth Management Limited;

•

Australian Shareholders' Association;

•

Corporate Super Association;

•

Equity Trustees Limited;

•

Financial Planning Association of Australia;

•

Grant Thornton Australia Limited;

•

Investment and Financial Services Association;

•

National Australia Bank Group;

•

Perpetual Limited;

•

Philanthropy Australia Inc;

•

Plan B Group Holdings Limited;

•

Sandhurst Trustees Limited;

•

Suncorp-Metway Limited;

•

Tasmanian Perpetual Trustees Limited;

•

Trust Company Limited;

•

Trustee Corporations Association of Australia; and

•

Westpac Banking Corporation.

7.137 Treasury has also undertaken face-to-face consultation with industry and other key stakeholders, including State and Territory Government officials, Philanthropy Australia and other stakeholders from the charitable trust sector. Treasury has also consulted with both ASIC and APRA in relation to their potential role.

7.138 The consultation process has revealed strong support from all stakeholders for the implementation of Commonwealth regulation of trustee companies. The face-to-face consultations, with both industry and the stakeholders in the charitable trust sector, and the large majority of written submissions have provided strong support for consumer protection and disclosure regulation with supervision by ASIC.

7.139 One of the biggest issues raised in consultation relates to the management fees and commissions that trustee companies are able to charge in relation to trust and estate management. All State and Territory legislation, except Western Australia and the Australian Capital Territory, prescribe fee caps and some restrict the source of income that the fee can be taken from. The Western Australia/Australian Capital Territory legislation model is a deregulation of fees, whereby trustee companies set a maximum fee through publishing a schedule of fees. Trustee companies are then able to change the schedule of fees as often as they like and can negotiate different fees with individual consumers. Once the trust arrangements commence the fees are locked in at the last published schedule of fees, unless otherwise specified in the trust deed.

7.140 Industry is very supportive of the Commonwealth regulation adopting this model (which will apply to all non-charitable trusts and estates). Industry claims that the current level of fees they are allowed to charge is unprofitable for the management of smaller trusts. Industry argues that in order to provide better service and more disclosure and transparency, they need to be able to charge adequately for their services.

7.141 Stakeholders from the charitable trust sector can see the potential benefits of a deregulation of fees for new clients. However, they are concerned that if fee caps are removed, trustee companies will take advantage of charitable trusts' inability to exercise market discipline and charge exorbitant fees on trusts that are already under management. Some charitable trusts currently under trustee company management do not have any fees prescribed in the trust deeds, so the trustee company can charge the maximum fee allowable under the existing legislation. Any increase in fees means less money is available for distribution to charity. Treasury is cognisant of the potential impact of removing fee caps and will seek to provide protection to trusts already under management through transitional arrangements.

7.142 Another significant issue raised in consultation was the issue of who are clients of trustee companies. Trustee companies have two types of clients:

•

primary clients are testators or settlors, who appoint the trustee company and put in place the terms and conditions of the will or trust; and

•

secondary clients are beneficiaries, who receive distributions when the trust arrangements commence.

7.143 Trustee companies raised concerns about disclosure and dispute resolution schemes applying to both client groups. They argue that the provision of relevant information to persons with a proper interest has always been a core duty of trustee companies under common law and does not need to be included in commonwealth regulation.

7.144 In some cases, the State and Territory Supreme Courts will have appointed a trustee company to manage the affairs of an individual when that individual does not have capacity to manage their own affairs, such as with minors or individuals with disabilities. In these cases, there is no primary client and the secondary client is often incapable of monitoring a trustee company's performance and management, even if they were provided with adequate information to do so. To cover these types of case, Treasury proposes to extend the consumer protection requirements to cover 'persons with a proper interest in the estate'. Industry request that, in order to protect against frivolous or mischievous requests for information, a reasonably tight definition of 'persons with a proper interest in the estate' is adopted in regards to who is entitled to obtain information on individual estates and trust under administration/ management.

7.145 Although industry was supportive for an external dispute resolution scheme to apply to their 'traditional activities' clients, they raised concerns about the scope of coverage and outcomes that could be achieved. Many trustee companies expressed the view that the decision to remove a trustee should remain with the Supreme Court.

Conclusion and recommended option

7.146 The Government considers that, on balance, the benefits of Option 2, consumer protection and disclosure regulation of trustee companies with supervision by ASIC, exceed the expected costs of implementation. The Government considers Option 2 preferable to the alternative Option 3, prudential regulation with supervision by APRA, because:

•

Option 2 addresses the main problem areas, whereas Option 3 would provide an unnecessary level of regulation (because the trustee companies hold the trust assets off balance sheet); and

•

the initial and ongoing costs would be less.

7.147 The manner in which Option 2 satisfies the objectives stated above can be briefly summarised as follows.

Objective 1

7.148 Enable approved corporations to operate as trustee companies and licence them under Chapter 7 of the Corporations Act.

Achieved by

7.149 Amending the Corporations Act (and the ASIC Act) to provide that: certain activities typically undertaken by trustee companies, such as acting as the executor/administrator of deceased estates, administering charitable trusts and foundations, managing common funds, and acting as a manager or guardian, are deemed to be 'financial services'; and trustee companies which hold an AFSL are authorised to provide such services, and must comply with the obligations of financial services licensees and any conditions imposed by ASIC. This option is optimal as it involves taking the best features of the State/Territory regimes and applying them in one single consumer protection law.

Objective 2

7.150 Ensure effective management and safeguarding of trust assets.

Achieved by

7.151 Amending the Corporations Act (and the ASIC Act) to ensure that trust property is clearly identified and held separately from property of the trustee company; enforcing the general obligations of AFSL holders, such as the requirements regarding adequate resources, competence and training, and any conditions imposed by ASIC; and preserving any relevant trust law and equitable remedies under State and Territory laws. This option is preferred to Option 3, as it provides the appropriate level of protection for trust assets.

Objective 3

7.152 Ensure appropriate disclosure to clients about the type of services and products being offered by the trustee company.

Achieved by

7.153 Ensuring that the trustee companies are subject to the relevant disclosure provisions of the Corporations Act, such as the Financial Services Guide (FSG), Statement of Advice and periodic statements provisions, and permitting electronic disclosure, so that settlors/testators and beneficiaries are informed both initially and periodically about the performance of trustee companies and trust assets.

Objective 4

7.154 Provide for lower cost dispute resolution, to enable beneficiaries to address issues of underperformance or incompetence and/or replace an underperforming trustee in a cost effective way, in cases where alternative dispute resolution is a viable alternative to the courts.

Achieved by

7.155 Requiring trustee companies to have appropriate internal and external (non-judicial) dispute resolution mechanisms for settlors/executors and beneficiaries, so that the need to approach a court is minimised.

Objective 5

7.156 Modernise the regulation of trustee companies and have any regulation apply on a national basis in accordance with Recommendation 90 of the Wallis Review and the Government's policy regarding reducing regulatory burden more broadly.

Achieved by

7.157 Replacing the current State and territory laws, with their overlapping and inconsistent rules, with uniform national legislation under the Corporations Act, and ensuring that the national law is up-to-date, for example in relation to directors' and officers' liability.

Objective 6

7.158 Facilitate a competitive national market for trustee companies.

Achieved by

7.159 Introducing a single national law for trustee companies under the Corporations Act and a single national regulator. This is expected to create a national market in which there are reduced barriers to competition (for example, the ability of beneficiaries to protect their interest in the estate by switching trustees) and fewer competitive neutrality issues (while noting that most public trustees will fall outside the new regime) and also reduced business compliance costs and improves efficiency of operations. It is also expected that the new approach to fees will promote efficient pricing of services provided by trustee companies.

Implementation and review

7.160 The first phase of the project will be accomplished by:

•

drafting appropriate provisions for inclusion in the Corporations Act;

•

asking ASIC to amend its applicable guidance (or produce new guidance) to accompany the legislation.

7.161 In the second phase, ASIC will devote appropriate resources to regulating trustee companies, including licensing, developing guidance and monitoring compliance.

7.162 The Government wishes to review the fee regime for charitable trusts and foundations for both existing and new clients after two years.

7.163 Further, it is expected that this option will be reviewed in its entirety under the Government's five-yearly review requirements. It is not proposed to include either a sunset clause or an automatic review clause.

7.164 The indicators against which success of the regime could be measured against include the extent to which:

•

the current overlapping/conflicting regulatory framework is replaced by a single, consistent set of rules that reduces business compliance costs and improves efficiency of operations, consistent with adequate regulation;

•

trust assets are appropriately managed and protected;

•

effective disclosure is made to clients (settlors/testators and beneficiaries) both initially and on an ongoing basis about the performance of trustee companies and trust assets;

•

clients can access lower cost, quicker dispute resolution, to enable them to address issues of underperformance or incompetence and/or replace an underperforming trustee in a cost effective way;

•

fees and charges reflect efficient pricing of services provided by trustee companies, while providing protection in particular to charitable trusts, deceased estates and disadvantaged persons; and

•

internal and EDR mechanisms deal with complaints from clients.

Chapter 8 - Regulation impact statement - Harmonisation of the treatment of debentures and promissory notes

Introduction

8.1 Over the past two to three years, there have been a number of high profile collapses of property development companies, starting with Westpoint and followed by Fincorp, ACR and Bridgecorp.

8.2 Consumers were able to invest in these property development companies by acquiring a debenture or promissory note issued by the company. In broad terms a debenture or a promissory note is a debt instrument.

8.3 The collapses have had significant impact with some investors losing considerable amounts of money. Total losses are estimated at around $900 million, invested by around 20,000 investors across Australia (although some of those funds will be recovered, particularly in the case of Fincorp and ACR).

8.4 There have been a range of reasons put forward to explain the collapses, other than the regulatory framework. These include poor corporate decision making; poor management; inappropriate use of funds; land banking, inexperienced personnel; high ongoing running costs; inappropriate or bad advice from financial advisers driven by higher than normal commissions; and, investors seeking higher than normal returns but not understanding the inherent high risk and unsecured nature of their investment.

8.5 Nevertheless, as a result of these corporate collapses there has been considerable discussion about the regulatory framework governing debentures and promissory notes and whether changes are appropriate.

8.6 In particular, these questions arise from the uncertainty about the Westpoint group's issue of promissory notes where clarification of whether they were regulated products was only achieved through the courts following a long and costly process. The uncertainty arose because of the belief by the issuing parties, Westpoint that the promissory notes they issued, which were valued at over $50,000, were not regulated by the Corporations Act 2001 (Corporations Act).

8.7 While the subsequent court decision made it clear that the promissory notes in question were interests in managed investment schemes and therefore were subject to regulation under the Corporations Act, it also highlighted the framework in relation to promissory notes is not sufficiently robust and doubts about its applications still exist.

8.8 Promissory notes valued at less than $50,000 are currently regulated as debentures. However, an inconsistency arises between the treatment of promissory notes valued at over $50,000 and debentures over that threshold. Given that debentures and promissory notes are broadly the same kind of financial product, this inconsistency provides a level of complexity and uncertainty in the marketplace resulting in ongoing suggestions that a regulatory gap exists.

8.9 The exclusion of promissory notes with a face value of more than $50,000 from the definition of debenture dates back to 1981. The original purpose of introducing the $50,000 threshold appears to have been to delineate between sophisticated investors and the investing public needing greater protection (similar to the retail/wholesale delineation today), but not impede normal banking and commercial dealings where that protection is not needed. Also at that time, industry participants were opposed to a definition of debentures which included negotiable instruments such as bills of exchange and promissory notes. The main reasons appear to be administrative issues and the imposition of stamp duty if the instrument was classed as a debenture.

8.10 Some 27 years later this exclusion level is out of date, particularly when compared to the $500,000 threshold which currently applies before an investor can be called sophisticated.

8.11 Further, there are circumstances where an issue of a promissory note valued at over $50,000 can escape the operation of the Corporations Act altogether:

•

if a promissory note valued at over $50,000 is not issued as an interest in a managed investment scheme and does not fit within the definition of a financial product (so it would then be regulated under Chapter 7 of the Corporations Act), it would not be defined as a financial product. To be defined as a financial product, the promissory note would need to generate a return to the investor and the investor would not have day-to-day control over their investment;

-

this anomaly also needs to be addressed.

8.12 Indeed, there is the possibility that promissory note issuers are already structuring their arrangements to avoid the operations of the Corporations Act.

Example 8.1 : Case study - Westpoint

Westpoint was a privately owned property development company located in Perth, Western Australia. Westpoint was active in several capital cities across Australia, including Melbourne and Sydney. Westpoint collapsed in early 2006 after insolvency proceedings were instigated by Australian Securities and Investments Commission (ASIC) in November 2005.

The difficulties experienced by Westpoint relate to a number of projects for which part of the funding was raised through the issue of promissory notes valued at more than $50,000 to retail investors. This so-called mezzanine financing promised high yields of up to 12 per cent per annum, but was secured only by second mortgages over the properties under development. Investors in these notes therefore ranked behind senior debt holders when the projects were wound up.

Promissory notes are regulated as debentures if they have a face value of less than $50,000. The Westpoint notes were issued with a face value of over $50,000 for the purpose of trying to avoid the disclosure and other requirements in law. ASIC took Westpoint to court to clarify the regulatory status of the promissory note. After appeal, in June 2006, the court confirmed that the promissory notes on issue were interests in a managed investment scheme and therefore subject to the disclosure and other requirements under the Corporations Act.

It has been estimated that some 3,000 to 4,000 investors lost approximately $300 million through the promissory note issues. The majority of Westpoint's companies are now in liquidation. Various legal actions continue against the directors of the company as well as related parties. Currently 19 licensed financial planners and three unlicensed financial planners have been banned for various periods from holding an Australian financial services licence (AFSL).

Had it been clearer in law that promissory notes valued at more than $50,000 were caught under the Corporations Act and therefore subject to the disclosure requirements, then the extended and expensive court case would not have been required and investors' funds may have been better protected.

8.13 The Westpoint problem identified a shortfall in the regulatory system - both in terms of the inconsistency in the thresholds relating to how financial products are regulated ($50,000 versus $500,000) and uncertainty and inconsistency of the regulatory approach between debentures and promissory notes depending on their value.

8.14 While ASIC has now issued additional guidelines for debenture issuers and trustees which require additional disclosure, this does not address the inconsistency in the treatment of both products, nor do the guidelines apply to promissory notes.

8.15 Further, the Parliamentary Joint Committee in its oversight report on ASIC published in March 2007 recommended that an amendment to the disclosure requirements in the Corporations Act to the $50,000 threshold applying to promissory notes be sought.

8.16 ASIC also supports the Government's intention to review the regulation of debentures and promissory notes.

Current arrangements

Regulation of debentures

8.17 Debentures are regulated under the Corporations Act (Chapter 2L). Debentures are debt instruments used by the issuer or borrower to raise funds from investors in return for the payment of interest.

8.18 The features of the regulatory regime include the following:

•

Debenture issues are required to be governed by a trust deed and must have a trustee. The trustee is required to undertake certain specified actions intended to safeguard the interests of debenture holders. It is also specified who can act as a trustee.

•

The trust deed must provide certain rights on behalf of debenture holders and trustees must act in the interests of debenture holders as defined under the Corporations Act.

•

The duties of the borrowers are defined, including the requirement to conduct their business in a proper and efficient manner and to provide certain reports with specified contents to the trustee and to ASIC.

•

Different naming rules apply to debentures under the Corporations Act depending on the nature of the debenture being issued, that is, whether it is a 'mortgage debenture', 'debenture', 'unsecured note' or 'unsecured deposit note'. The rules generally reflect the type of security available over the debenture.

•

Debentures are issued as a source of finance for a range of business activities, including debt capital funding, mortgage lending for residential or commercial property, participation in and ownership of commercial and residential real estate, or to facilitate membership of clubs, groups or franchise operations.

•

Debenture issues can be listed or unlisted and can be secured or unsecured.

Unlisted issues of debentures

8.19 It has been identified that unlisted and unrated debentures pose an increased risk for retail investors. In particular, investors do not have the benefit of the market to provide:

•

a readily available value for the debenture;

•

public scrutiny of the ongoing performance of the issuer either through market forces or via listing rules, as would be the case if the issue were in the public domain; and

•

an easy market for the sale of their interests, particularly where investors may have lost confidence in their investment.

8.20 Risks to investors further increase where the funds provided through the issue are on lent, often through other companies in the group for property development purposes as there is considerable uncertainty about returns until such time as the developments are completed and sold. ASIC has issued revised guidelines to immediately address these risks for consumers - see below.

Regulation of promissory notes

8.21 Promissory notes are used to raise funds, such as those issued in the Westpoint case.

8.22 The formal characteristics of promissory notes are covered by the Bills of Exchange Act 1909. However, the investor protection regime, including disclosure, licensing and conduct rules, is contained within the Corporations Act.

8.23 Promissory notes are regulated in the Corporations Act either as debentures or as financial products depending on their value:

Less than $50,000 = debenture

•

Promissory notes under $50,000 are regulated as debentures (Chapter 2L):

-

debenture issues are governed by a trust deed and trustee (Chapter 2L) and must be accompanied by a prospectus (Chapter 6D);

-

issuers and/or financial advisers must also meet relevant disclosure, conduct and licensing requirements (Chapter 7).

$50,000 or over = financial product

•

Promissory notes valued at $50,000 or over are excluded from the definition of debentures (s9) and are regulated as a financial product (Chapter 7):

-

promissory note issuers must therefore provide a Product Disclosure Statement (PDS) (Part 7.9 in Chapter 7).

•

Sometimes promissory notes are issued in the form of an interest in a Managed Investment Scheme:

-

as such, the Managed Investment Scheme must be registered and have a licensed responsible entity in place; and

-

each Managed Investment Scheme must provide a PDS (Chapter 7).

(a)

Westpoint mezzanine/promissory note issues were characterised as Managed Investment Schemes by the Western Australian Supreme Court.

•

Some promissory notes may not satisfy the definition of either a debenture or a financial product;

-

however, most promissory notes are likely to fall under one of these two categories.

8.24 The current regime is summarised in the Table below.

Table 8.1 : Summary of the current regulatory framework for promissory notes

ASIC's work

8.25 In analysing some of the reasons for the various property development company collapses, since early 2007, ASIC has prioritised the area of unlisted and unrated debentures as a high risk sector. To date, ASIC has released two sets of guidelines addressing the two areas of immediate concern, to improve disclosure in relation to the unlisted unrated debentures market and setting out guidelines on the way these products are advertised.

•

The guidelines set out specific measures to provide better quality information to retail investors about the risks of such investments.

8.26 ASIC also established a Retail Investor Task Force to undertake research into the retail investment sector, focusing on improving retail investor education generally to assist retail investors better understand their investment options and the risks they may incur.

8.27 ASIC has now issued a Guide for investors in unlisted debentures to assist them in making better informed decisions about this type of product and the risks involved. The work of the Retail Investor Task Force also informed the strategic restructure of ASIC which has established a structure it feels is better placed to undertake its regulatory role, including a specific team to deal with retail investors and consumers.

8.28 However, again, these guidelines do not address the area of promissory notes valued at over $50,000.

Systemic risks with collapses in this sector

8.29 Even after the fallout from the collapses which attracted significant media attention, studies suggest that retail investors still have a high degree of confidence in their own ability to make appropriate investment decisions. Westpoint promissory notes were issued without any disclosure documents and with the promise of high returns, leaving investors to make decisions without the level of disclosure that applies to other financial products - however investors were happy to make the decision to invest regardless at that time.

8.30 However, following the collapse of Westpoint and other companies, investors have been quick to complain to the Government and ASIC about their losses.

8.31 Low investor confidence can lead to a general loss of confidence in the high yield finance sector and potentially may result in investors withdrawing funds from companies active in the sector. In a worst case scenario this could lead to further collapses through a snowball effect. This happened in New Zealand where over 20 finance companies have collapsed, leading to a general loss of liquidity in the sector.

8.32 The current financial crisis has compounded this impact on investor confidence.

8.33 Collapses can therefore have systemic implications, impacting:

•

individual savings, leading to increased reliance on Government pensions, with a corresponding Budget impact;

•

general confidence levels in debenture issues, which may lead to viable companies collapsing due to liquidity shortfalls, as has happened in New Zealand; and

•

the financing of fundamentally viable projects, which may not be able to proceed with potential wider consequences for employment and economic growth.

8.34 It is therefore important to ensure the investor protection regime is sound and robust and that retail investors investing in these products are provided with sufficient resources to make informed decisions.

8.35 Any action also needs to be balanced against the risk of increasing costs for business.

Objectives of Government action

8.36 The Government aims to provide a robust system where investors are provided with appropriate protective mechanisms. Where perceived or real regulatory gaps exist, it is appropriate for the Government to undertake a review.

8.37 Eliminating uncertainty about the regulation of promissory notes in the marketplace would be the main current objective.

8.38 Given the $50,000 cut-off level dates back to 1981, it is timely to reconsider whether this threshold is still appropriate. This is particularly so given that a person who invests $500,000 or more for a financial product is considered to be a sophisticated investor and the same protections therefore do not apply.

Consultation

8.39 In this context, in June 2008, the Government issued the Financial Services and Credit Reform Green Paper. The Green Paper addressed six issues in the financial services sector for possible reform, including the debentures sector. The Green Paper was made available on the Treasury website and a media release was issued.

8.40 Four potential changes to the regulation of the debentures sector were proposed in the paper, relating to:

•

harmonisation of the regulation of promissory notes;

•

licensing of debenture issuers;

•

licensing of trustees; and

•

review of trustee duties.

8.41 However, subsequent to the issue of the Green Paper, it was agreed that while the harmonisation issue should be addressed now, consideration of the three remaining reforms be deferred until the conclusion of ASIC's debenture review project. This will allow the considerable work already commenced by ASIC to improve the consumer protection framework in this area to be thoroughly assessed before any further changes, which may not prove necessary, are implemented.

8.42 ASIC's review will look into the effectiveness of its recently revised (2007) guidelines on improved disclosure and advertising of unlisted, unrated debentures. Once completed a further assessment of the remaining three items will be undertaken.

Submissions

8.43 Twenty submissions were received in relation to the debentures chapter in the Green Paper. Fourteen out of the 20 submissions received were in favour of the harmonisation proposal. The general feeling was that this option was a positive step as the regime needed to be more consistent to ensure better investor protection.

8.44 Of the remaining submissions, some did not comment specifically on the harmonisation option, and only one party, a law firm, set out any concerns. They argued that increasing the regulation of promissory notes regardless of their value was inconsistent with the rest of the Corporations Act which makes a distinction between the nature of the offering and the level of risk. For this reason, it considered the change was discriminatory without sufficient basis.

8.45 Further targeted consultation will be undertaken in relation to the harmonisation proposal, to establish whether a change to the regulation is appropriate and to assess the level of any impact.

Options

Option 1 - No change

8.46 This option would leave the current regulatory framework in place, thereby retaining the threshold levels between a debenture and a promissory note valued at over $50,000.

Option 2 - Harmonise the regulation of debentures and promissory notes

8.47 Regulate promissory notes valued at over $50,000 in the same way as debentures. This would be achieved by removing the exclusion of promissory notes from the definition of debentures in section 9 of the Corporations Act.

Option 3 - Self regulation

8.48 Issuers of promissory notes valued at over $50,000 would be required to manage their own actions in regard to the issue of promissory notes and apply in the relevant regulatory framework that issue including appropriate disclosure.

Impact analysis

Impact group identification

8.49 The groups affected by the amendments are investors/consumers, the promissory notes industry and issuers of promissory notes, the Government and ASIC.

Assumptions

8.50 In assessing the impact of the options, the following assumptions have been used based on some research undertaken by ASIC and submissions received from the earlier Green Paper consultation process.

•

The estimated total value of debentures currently on issue in Australia is around $25 billion, down from $34 billion at June 2006.

•

The number of issuers is estimated to be 146, compared with 154 previously at June 2006.

•

The numbers of investors holding interests in promissory notes or who intend to acquire interests in promissory notes valued at more than $50,000 is likely to be lower again.

•

The majority of investors had invested between $20,000 and $499,999 (representing 49 per cent of those surveyed). The higher end is more likely to reflect investment property ownership.

•

In the case of the Westpoint collapse, over 3,000 investors were affected.

•

Our understanding is that there are only a limited number of promissory note issuers.

•

There appear to be more investors in promissory notes in the over $500,000 sector, but these would be classed as wholesale investors and any changes would not impact on this sector.

•

In the then Financial Literacy Foundation's 2007 survey of 7,500 people, approximately 46 per cent said they had investments other than property. However this survey did not differentiate between retail and wholesale investors. The survey group also comprised around 550 participants who were under 18 years of age.

•

According to ASIC's annual report for 2006-07, the number of licensed financial advisers were 4,625. However, it is unlikely that the proposed change would have any impact on advisers. In the assessment below, financial advisers are included under the category of 'industry'.

•

Costs can take many forms including: setting up trustee arrangements, including a trust deed and trustee, court costs, or in the form of lower confidence in the marketplace.

8.51 Further consultations on the options will better determine the overall impact and associated costs and benefits.

Assessment of costs and benefits

Conclusion and recommended option

8.52 Promissory notes valued at over $50,000 are currently regulated differently to debentures for reasons that are no longer relevant. The original reasons for creating the discrepancy in 1981 appear to have come about because at that time industry participants and stakeholders opposed the broad definition of debentures including negotiable instruments such as bills of exchange and promissory notes. This appears to relate to administrative issues and the imposition of stamp duty if the instrument was classed as a debenture. Those concerns appear less relevant now.

8.53 Additionally, the $50,000 threshold has remained unchanged since 1980 and is out of date compared to the current thresholds differentiating between retail and sophisticated investors.

8.54 The current arrangement creates an inconsistent approach between the regulation of debentures and a promissory note valued at more than $50,000. This inconsistency does not appear to be warranted any longer.

8.55 Indeed, 14 of the 20 submissions from the Financial Services and Credit Reform Green Paper issued in June this year on debentures supported this option. Only one submission was against the proposed change, and its further views will be sought as part of the next round of targeted consultations.

8.56 Allowing the industry to address the problem itself (Option 3) is less likely to satisfy industry and investors in particular that they will be protected. Nor does this option meet the objective of providing clarity in the regulation of promissory notes.

Discussion of Options

8.57 Option 1 offers no real solution to the problems existing in the current regime, particularly the uncertainty that exists and the threshold anomaly.

8.58 Option 2 is the option put forward by the Government in its Green Paper released in June 2008. Implementation of this option will mean those promissory notes governed under the Corporations Act currently valued at greater than $50,000 would be regulated as debentures. This approach is seen to address the perceived regulatory gap and inconsistent regulatory framework between promissory notes and debentures.

8.59 Consequently, new issuers of promissory notes valued at more than $50,000 will have to meet the requirements of Chapters 2L and 6D - requiring the establishment of trustee arrangements and the issue of a prospectus.

•

This change will affect the issue of promissory notes to retail clients only and will provide a clearer framework to which issuers must adhere.

8.60 From our understanding of the market, the majority of promissory notes (commonly termed commercial paper) on issue are valued at over $500,000. We also understand that the majority of issuers are the major banks. Any increased costs as a result of the proposed change would therefore be expected to be low relative to their overall operations.

8.61 The greatest impact from this change is likely to be felt by issuers of promissory notes in the range of $50,000 to $500,000. Issuers in this range (who may or may not already be licensed depending on their business operations) will be required to establish trustee arrangements for the issue of promissory notes and comply with the prospectus disclosure requirements. It is noted that most of these issuers are currently subject to other disclosure requirements, depending on the nature of the promissory note issue, including the obligation to provide a Product Disclosure Statement. While the Product Disclosure Statement requirements differ from those applying to prospectuses, they result in a similar level of information being provided to retail investors.

8.62 While affected entities may object to any changes being imposed on them in complying with the new disclosure and trustee arrangements, that number is expected to be relatively low and the costs not onerous. Further targeted consultation will provide information in this regard.

8.63 Option 2 offers a sensible approach to address an inconsistent legislative framework where many feel a regulatory gap exists.

8.64 Option 3, self-regulation by the industry, may go some way to protecting investors provided that industry participants issue promissory notes as a regulated financial product and do not attempt to fight the system again as Westpoint did. However it does not provide a complete answer.

8.65 Through Option 2, issuers of promissory notes would be regulated like any other debenture issuer. This framework would also provide a consistent approach.

8.66 Currently, when a promissory note is issued valued at over $50,000, it may even be regulated as a financial product under Chapter 7 more as an interest in managed investment scheme. Yet a promissory note valued at less than $50,000 would be regulated under the framework for debentures. This provides a level of complexity in the issue of promissory notes. It makes sense therefore to include promissory notes valued at over $50,000 in the same regime as debentures.

8.67 Under the debentures regime, all promissory notes issuers would therefore be required to establish trustee arrangements, including setting up a trust deed and appointing a trustee. Amongst a range of duties, the trustee is required to protect the interests of debenture holders including to actively monitor the financial position and performance of the issuer. This role has been further enhanced by the recently released ASIC guidelines for debenture issues.

8.68 Trustees are also required to look after the interests of debenture holders by exercising reasonable diligence in monitoring the issuer's ability to repay the debentures - this is not required under the current framework for promissory notes. Issuers are required to report regularly to the trustee and the trustees are also required to ascertain whether the issuer has committed any breach under the trust deed of Corporations Act and this includes general obligations to carry on their business in a proper and efficient manner.

8.69 Additionally, ASIC has also issued a separate guide for retail investors interested in investing in debentures and this provides an additional level of additional information for investors to make appropriate decisions about their investments.

Conclusion

8.70 The inconsistency in the regulation of debentures and promissory notes has raised a number of questions about whether this discrepancy could be exploited again. The proposed harmonisation option would create more consistency in the regulation of both while also providing an opportunity to remove the anachronistic $50,000 threshold.

8.71 Therefore, the preferred way forward is to remove the exclusion of promissory notes valued at over $50,000 from the definition of a debenture, resulting in debentures and promissory notes being consistently regulated as debentures under the Corporations Act.

Implementation and review

8.72 Further targeted consultation will confirm whether this option is appropriate and identify any potential unexpected consequences, particularly within the commercial market.

8.73 Targeted consultation will involve a six week consultation period. Those consulted will be based on the submissions on this subject received from the Green Paper.

8.74 It is proposed that any proposed changes will be added to another Bill due to be tabled in the winter sittings next year.

8.75 It is likely that no transitional period will be required as issuers will be well aware of the changes before final implementation and the impact would not be sufficient to warrant a transition phase. This would also be subject to further review following final submissions.

8.76 Any future review will be undertaken as deemed necessary and subject to the long-term effects on the marketplace and the regulator's advice.

8.77 Ongoing enforcement and monitoring would be undertaken by the financial services regulator, ASIC.

Index

Schedule 1: Margin loans

Schedule 2: Regulation of trustee companies

Schedule 3: Regulation of debentures

Schedule 4: Technical amendment relating to jurisdiction of courts

Schedule 5: Application and transitional provisions