House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

6 Introduction and preliminary matters

Commencement of the Bill

6.1 The FSR Bill proposes amendments to the proposed Corporations Act which provides for a Commonwealth regulatory regime for corporations and the securities and futures industry based on a referral of powers from the States. Generally the FSR Bill will not commence at a minimum until immediately after the Corporations Act 2001 commences (subclauses 2(3) and (4)). Provision is also made for the Bill to commence any time within 12 months after the commencement of the Corporations Act 2001 (subclause 2(6)).

6.2 Part 1 of Schedule 3 which contains amendments to the proposed Corporations Act arising from changes made to the Corporations Law by the Corporate Law Economic Reform Program Act 1999 (the CLERP Act) and the Managed Investments Act 1998 will commence on Royal Assent or if the proposed Corporations Act has not commenced, immediately after it commences.

Scope of the FSR Bill

6.3 The FSR Bill is to replace a range of existing regulatory requirements including:

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Chapters 7 and 8 of the proposed Corporations Act;

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the Insurance (Agents and Brokers) Act 1984 ;

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aspects of the Superannuation Industry (Supervision) Act 1993 and the Retirement Savings Account Act 1997 and regulations and the Insurance Act 1973 ;

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aspects of the Banking (Foreign Exchange) Regulations.

6.4 Consequential amendments will also be necessary to other legislation, including the proposed Corporations and ASIC Acts and the Insurance Contracts Act, to accommodate changes being made by the FSR Bill.

6.5 Part 1 of Schedule 1 contains the proposed main amendments to the proposed Corporations Act for the establishment of a new regulatory regime for the financial services industry. The Part repeals Chapters 7 and 8 of the proposed Corporations Act dealing with the regulation of the securities and futures industry and inserts a new Chapter 7. Part 2 of Schedule 1 contains the proposed consequential amendments to the proposed Corporations and ASIC Acts necessary to accommodate the FSR Bill.

6.6 Further legislation will be required to make the consequential amendments to other legislation necessary as a result of the FSR Bill. These amendments will be in place prior to the commencement of the FSR Bill.

Key definitions

General definitions

6.7 Proposed Division 2 of Part 7.1 contains the key definitions applicable to Chapter 7 of the proposed Corporations Act. They will replace some of the existing definitions in Part 1.2 of the proposed Corporations Act and have been drafted so that they are capable of application to the full range of financial products that are to come within the Chapter. For example, the concept of able to be traded will replace the term admitted to quotation in relation to Chapter 7 to reflect the fact that the provisions will apply to all financial markets and not just those in relation to securities. Similarly, the concepts of acquire and dispose have been defined broadly to capture the wide range of products that are subject to the Chapter.

6.8 Part 2 of Schedule 1 contains further proposed amendments as a result of the FSR Bill to the definitions contained in Part 1.2 of the proposed Corporations Act. It also contains consequential amendments to other provisions in the proposed Corporations and ASIC Acts as a result of the changes being made by the FSR Bill. For example, a definition of futures contract will no longer be required and will be replaced by the definition of derivative.

6.9 For the most part definitions that are particularly relevant to certain parts of the Bill are considered in relation to those parts. Definitions that are relevant for the whole of the Bill are discussed below.

Retail/wholesale distinction

6.10 The Bill draws a distinction between retail clients and wholesale clients. Additional protections are afforded to retail clients in the form of:

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the Financial Services Guide;

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the Statement of Advice;

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the Product Disclosure Statement; and

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compensation and complaint handling arrangements.

Preliminary

6.11 Proposed subsection 761G(1) emphasises the underlying assumption of proposed section 761G, that financial products or financial services are provided to a person as a retail client except where the provision clearly states otherwise. Such a person is then also taken to acquire and dispose of the financial product or service as a retail client (proposed subsections 761G(2), (3)). That a person who does not acquire a financial product or service as a retail client is a wholesale client is put beyond doubt by proposed subsection 761G(4).

General insurance products

6.12 The definition in proposed section 761G distinguishes between:

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general insurance products;

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superannuation interests; and

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other kinds of financial products.

6.13 Proposed subsection 761G(5) applies to make either an individual or a small business (as defined in proposed subsection 761G(11)) a retail client, where they purchase one of the listed general insurance products. However, in the case of a small business, the product must be purchased for use in connection with that business.

6.14 The listed general insurance products are as follows:

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Motor vehicle insurance;

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Home building insurance;

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Home contents insurance;

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Sickness and accident insurance;

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Consumer credit insurance;

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Travel insurance;

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Personal and domestic property insurance; and

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such other general insurance as is prescribed by the regulations.

6.15 These types of insurance will be defined in the regulations. The first six listed types of insurance replicate those defined to mean standard cover in the Insurance Contracts Act and Regulations. These are essentially policies for personal, domestic and household protection, or consumer policies. Personal and domestic property insurance is currently covered by insurance complaints handling mechanisms and, as a consumer type of insurance, has also been included.

6.16 A person will therefore be a wholesale client where:

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the person acquires any type of general insurance policy not included in the list; or

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the person acquires a product in the list but is not an individual; or

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the person acquires a product in the list but is not acquiring the product for use in connection with a small business.

Superannuation and RSA products

6.17 Proposed subsection 761G(6) provides that where a person acquires a superannuation product or a retirement savings account (RSA) product, or a financial service related to one of these, the person acquires the product as a retail client. This test is not restricted to individuals and small businesses, but applies to all persons, regardless of their circumstances. This subsection was included due to the difficulty in drawing any meaningful distinction based on product value between retail and wholesale clients in relation to superannuation and RSAs, given the large amounts frequently involved in superannuation payouts, for example.

Other kinds of financial product

6.18 Proposed subsection 761G(6) provides that a financial product (other than general insurance, superannuation and RSAs), or a financial service related to such a financial product, is provided to a person as a retail client except in four instances:

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where the price of the financial product, or of the product in relation to which the financial service is provided, exceeds the prescribed amount;

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where the business acquiring the product or service is above a certain size (that is, not a small business);

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where an individual provides evidence of a nominated level of personal wealth; or

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where the person is a professional investor.

Product value test

6.19 The test in proposed paragraph 761G(7)(a) is based on the assumption that persons who can afford to acquire financial products or services with a value above the prescribed amount do not require protection as retail clients, as they may be presumed to have either adequate knowledge of the product or service, or the means to acquire appropriate advice.

6.20 The prescribed amount will be set by regulation. It is proposed to set the prescribed amount initially at $500,000 consistently with the sophisticated investor test in paragraphs 708(8)(a) and (b) of the existing Corporations Law. However, regulations made under proposed subsection 761G(8) will also allow the amount to be varied in particular circumstances, if necessary.

Business test

6.21 The exception in proposed paragraph 761G(7)(b) results in big business being treated as wholesale clients in relation to a financial product or service provided for use in connection with that business. There is no definition of big business in the FSR Bill, instead it is defined negatively by reference to the definition of small business in proposed subsection 761G(11).

6.22 Therefore, small businesses receive protection as retail clients under the regime, provided the financial product or financial service is acquired for use in connection with that business. A small business is defined in proposed subsection 761G(11) as one that employs fewer than:

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if it is a manufacturing business - 100 people; or

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otherwise - 20 people.

Individual wealth test

6.23 This exception is also based on the concept of sophisticated investor in paragraph 708(8)(d) of the existing Corporations Law. Proposed paragraph 761G(6)(c) enables a person to provide evidence that they have:

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net assets of at least $2.5 million; or

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gross income for each of the last two financial years of at least $250,000.

6.24 If a person produces a certificate to this effect, they will not be regarded as retail. Wealthy individuals may therefore choose to decline the retail protections, presumably on the basis that they either have considerable experience in making investments or have the means to seek appropriate advice.

Professional investor test

6.25 A professional investor test, based on the current test in subsection 708(11) of the existing Corporations Law has been introduced into the Bill in proposed paragraph 761G(7)(d). The definition of professional investor will be inserted into section 9 of the proposed Corporations Act (for the purposes of subsection 708(11) as well) and covers persons who are:

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financial services licensees;

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bodies regulated by the Australian Prudential Regulation Authority (APRA);

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bodies registered under the Financial Corporations Act 1974 ;

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trustees of superannuation funds, approved deposit funds, pooled superannuation trusts and public sector superannuation schemes within the meaning of the SIS Actwhere the fund, trust or scheme has net assets of at least $10 million;

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control at least $10 million (including any amount held by an associate or under a trust that the person manages);

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listed entities or related bodies corporate of listed entities;

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exempt public authorities;

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investment companies as defined by Corporations Regulation 7.3.12(3); and

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foreign equivalents of the above.

6.26 The professional investor test was included in response to considerable concern by industry that retail protections would otherwise apply to financial and investment entities that fell within the definition of small business.

Product value test - regulation making power

6.27 Proposed subsection 761G(8) allows the making of regulations to vary the application of the product value test in proposed paragraph 761G(7)(a), including varying the prescribed amount in relation to particular financial products. As superannuation interests are now dealt with separately in proposed subsection 761G(6), a particular application for this power is not currently envisaged. However, the existence of the power will ensure maximum flexibility in the application of the product value test.

Packages of financial products

6.28 Proposed subsection 761G(9) makes it clear that where a person acquires a package including both general insurance products and other kinds of financial products, these products must be separately assessed against the relevant subsections to determine whether a person must be treated as retail in respect of that element of the package.

Presumption of retail client

6.29 Proposed subsection 761G(10) reasserts the rationale underpinning the provision, that persons must be treated as retail clients unless it is clearly stated otherwise. This presumption applies only to financial products covered by the test in proposed subsection 761G(7), as the tests in proposed subsections (5) and (6) do not require such a presumption.

Small business definition

6.30 The definition of small business included at proposed subsection 761G(11) is discussed above in relation to the business test in proposed paragraph 761G(c).

Definition of financial product

6.31 Division 3 of Part 7.1 establishes the scope of the proposed new Chapter 7 in terms of the financial products to which it applies. As a general rule, all parts of the Chapter will apply to the full range of financial products as defined in this Division. That is, a person performing a particular function in relation to any of those products, such as operating a financial market or providing financial advice, will have to comply with the relevant parts of the Chapter.

6.32 However, some specific elements of the regime will apply on their face to a more limited range of financial products. For example, proposed Part 7.9 dealing with financial product disclosure (see Part 14 of this Explanatory Memorandum) will not apply to a security (as defined in proposed section 761A). There is also the facility within a number of elements of the regime to narrow the scope of products to which particular provisions are to apply, either by regulation or through an ASIC exemption and modification power. For example, Part 7.9 has both a regulation-making power and an ASIC exemption and modification power, which would enable the application of those provisions to particular financial products to be narrowed.

Basic deposit products

6.33 Special rules also apply in a number of areas of the FSR Bill to reduce the intensity of regulation in relation to basic deposit products and related non-cash payment facilities on the basis that such products are capital guaranteed and well understood by consumers:

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employees of representatives authorised to provide services in relation to such products need not be authorised (proposed paragraph 911B(1)(c));

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a Financial Services Guide need not be given for a dealing in such a product, but an oral statement must be given (proposed subsection 941C(6));

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a Statement of Advice is not required, but certain information must be given (proposed subsection 946B(5)); and

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a Product Disclosure Statement may be given after the product is issued (proposed paragraph 1012G(1)(b)).

6.34 These rules have been relaxed on the basis that a customer can withdraw from a basic deposit product at any time without any loss of capital, other than transaction fees. Proposed section 761A defines a basic deposit product as a deposit product with a term of two years or less, allowing for the immediate withdrawal of funds without penalty other than the reduction of the interest rate, and with no entry and exit fees or ongoing management charges.

6.35 There is also provision for these special rules to be extended to other financial products by regulation.

Approach to defining financial product

6.36 The Bill takes a three-part approach to the definition of financial product which is outlined in proposed section 762A:

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a broad general definition of financial product which focuses on the key functions performed by financial products;

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this general definition is then clarified or added to by a list of specific inclusions and a regulation-making power to include further products. The list of inclusions is not a catch all list, but rather provides examples of products that fall within the general definition. The list is also drafted in such a way that it will bring products within the regime whether they fall within the general definition or not;

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the scope of both the general definition and the specific inclusions is then narrowed by a list of specific exclusions, a regulation-making power to exclude products and an ASIC exemption power;

6.37 This approach is intended to provide significant flexibility in defining the financial products that are to come within the regime and will be able to cater for emerging products without the need to amend the legislation.

6.38 Where a facility includes a number of components, only one of which is a financial product, the Chapter will only apply to the facility to the extent to which it consists of a financial product (proposed section 762C). For example, some banking products may involve dual credit and debit facilities. The Bill will only apply to the debit aspects of the facility and not the credit aspects.

General definition

6.39 The general definition in proposed Subdivision B of Division 3 focuses on three key functions that financial products provide:

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making a financial investment;

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managing a financial risk; and

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making non-cash payments (see proposed subsection 763A(1)).

Facility and arrangement

6.40 What amounts to a financial product that enables a person to do one of the things specified in proposed subsection 763A(1) is defined broadly as a facility through which, or through the acquisition of which, the person does those things. A facility is taken to include intangible property or an arrangement or term of an arrangement or both (proposed section 762C). For example, a share would be intangible property through the acquisition of which a person makes a financial investment.

6.41 Arrangement is also defined broadly, along the lines of the definition of Chapter 8 agreement in existing section 9 of the Corporations Law to include formal and informal arrangements, whether oral or in writing and whether enforceable or not (proposed section 761A).

6.42 Two or more arrangements are also taken to constitute a single arrangement if this is what the parties intended (proposed section 761B). This is intended to pick up certain transactions which, if viewed separately, might not be regarded as a financial product, but if viewed together would be. This could be particularly relevant in relation to certain derivative transactions. For example, parties could enter into a deliverable commodity agreement and then a further agreement under which the party receiving the goods agrees to sell a similar quantity of goods back at market price. Neither agreement, of itself, would fall within the definition of derivative (see discussion below), but combined they would.

6.43 This provision only applies where an arrangement by itself would not amount to a financial product and does not apply to combine arrangements that would otherwise be financial products into a single arrangement. In that case, each arrangement is to be regarded separately as a financial product in its own right.

Particular persons purpose for acquisition irrelevant

6.44 A facility will be regarded as one for making a financial investment, managing a financial risk or making a non-cash payment even if this is not the purpose for which it is acquired, if it is the purpose for which a product of that kind is commonly acquired (see proposed subsection 763A(2)). For example, a particular person may enter into a derivatives transaction with a speculative purpose in mind. Notwithstanding this, the transaction will be regarded as one for managing a financial risk since persons commonly acquire such products to manage financial risks.

Secondary sale of financial products

6.45 Proposed subsection 763A(3) deals with the secondary sale of financial products and provides that a facility that was originally a financial product retains that character when it is on-sold notwithstanding that the person who is acquiring the product is not making a financial investment or managing a financial risk. This is intended to ensure, for example, that products such as securities, which on initial issue come within the concept of make a financial investment, retain that character when they are on-sold even though they would no longer come within that concept. The provision would apply similarly to a warrant, that on initial issue was a facility for managing a financial risk, but would not otherwise be on secondary sale.

Incidental products

6.46 Proposed section 763E is intended to ensure that the definition of financial product does not pick up a range of consumer transactions that have an element, but not the primary purpose, of for example managing a financial risk. For example, the definition of managing a financial risk could potentially cover warranty periods or guarantees in contracts for the sale of goods, or card registration services with the incidental benefit that the consumer will not be liable of any unauthorised use of a credit card between the time the service is notified of the loss and the time the service notifies the issuing bank. Similarly, a security bond arrangement by a telecommunications provider, which provided for the payment of interest, could be a facility for the making of a financial investment. Under proposed section 763E where the financial product purpose (making a financial investment, managing a financial risk, or making a non-cash payment) is incidental to the main purpose of a facility, it is not to be regarded as a financial product.

6.47 Proposed section 763E only applies to the general definition of financial product. Thus to the extent that a product comes within the list of specific inclusions in proposed section 764A, it will come within the regime whether or not it is incidental to the main purpose of a facility. This means that products such as insurance associated with taking out a home loan or consumer credit insurance would be regulated under the regime, as would superannuation associated with a contract of employment.

Making a financial investment

6.48 The concept of making a financial investment in proposed section 763B is broadly based on the concept of managed investment scheme in the existing Corporations Law. It has 3 key elements:

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the investor contributing money or moneys worth;

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the generation or intended generation of a financial return or benefit. This takes account of the possibility of an investment giving rise to a loss. While the intention should be to generate a financial benefit, this may not always be the outcome; and

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the investor having no day-to-day control over the use of the money to generate the return.

6.49 The notes to the proposed provision contain examples of things that would and would not be regarded as making a financial investment.

6.50 By focussing on the actual, as well as the intended, use of the money the definition is intended to cover deposit accounts, which for many consumers are used for transactional purposes, although they also generate some return.

6.51 A provision in an arrangement for investment choice would not take a product outside the concept of making a financial investment. This would not be sufficient to amount to day-to-day control on the part of an investor.

6.52 While the definition is broadly based on the definition of managed investment scheme, the two terms are not intended to cover precisely the same field. Nothing in the definition of managed investment or making a financial investment is intended to limit the interpretation of the other. Both should be interpreted independently.

Managing a financial risk

6.53 Proposed section 763C is intended to bring within the regime as facilities for managing financial risk, products such as insurance contracts and derivatives. Concerns that the definition of managing a financial risk might encompass such things as warranties and guarantees associated, for example, with the sale of goods that are only incidentally intended to manage a financial risk are addressed by proposed section 763E.

Making a non-cash payment

6.54 Proposed section 763D brings within the regime facilities enabling a person to make non-cash payments. It would cover, for example, direct debit facilities, cheques, purchased payment facilities such as certain smart cards and electronic cash arrangements.

Money changing transactions

6.55 Pure money changing foreign exchange transactions are taken outside the definition of a non-cash payment facility by the exclusion of payments involving the physical delivery of foreign currency in the form of notes and/or coins. They are also specifically excluded from the whole definition of financial product by proposed paragraph 765A(1)(m).

Credit cards

6.56 By virtue of the exclusion of credit facilities from the regime as a whole (proposed paragraph 765A(1)(h)), it would not cover such products as credit cards which facilitate the making of non-cash payments. Such cards, to the extent that they are used for domestic, personal or household use, are currently regulated under the Uniform Consumer Credit Code (UCCC). The will also be subject to the general consumer protection provisions in Division 2 of Part 2 of the ASIC Act.

Ultimate settlement systems

6.57 Similarly, through the list of specific exclusions, it is made clear that certain payments systems and other arrangements for the making of payments through such systems (such as the arrangements established by the Australian Payments and Clearing Association Limited), and settlement systems as between providers of non-cash payment systems are not brought within the definition of a non-cash payment facility (proposed paragraphs 765A(1)(i), (j) and (k)).

Single merchant payment facilities

6.58 Facilities that only facilitate the payment to a single person, such as store cards (to the extent that they are not credit and already outside the regime) and phone cards, are taken outside the regime, as it is considered that the consumer risk can be dealt with adequately under the general consumer protection provisions in Division 2 of Part 2 of the ASIC Act. The definition of financial product in those provisions will be broader than the definition for the purposes of Chapter 7 to ensure that they cover such products. For similar reasons, limited purpose or person payment facilities may also be excluded by regulation (see proposed subsection 763D(2)). This is similar to the approach taken in section 9 of the Payment Systems (Regulation) Act 1999 in relation to purchased payment facilities.

Issuer of a non-cash payment facility

6.59 Who is the issuer of a particular financial product, including a non-cash payment facility, is dealt with in proposed section 761E. In particular, proposed subsection 761E(4) makes it clear that the issuer of the product is the person who is responsible to the client or for the obligations owed under the terms of the product. In relation to non-cash payments such as direct debit facilities, the issuer of the facility (who is subject to certain obligations under proposed Chapter 7, including financial service provider licensing and product disclosure) is the financial institution with which the account to be debited is held, rather than the person to whom payments can be made using the facility. Similarly, in relation to Automated Teller Machines (ATMs) it would be the financial institution with which the account being credited or debited through the use of the machine that would be the provider of the facility, not the supplier of the ATM.

6.60 Proposed paragraph 765A(1)(x) also excludes equipment or infrastructure by which something else that is a financial product is provided. This is intended to exclude the ATM itself or, for example, the services of telecommunications companies through which certain bill payment facilities operate. It is not intended to exclude the provision of financial services, such as custodial and depository services, in relation to financial products.

Specific inclusions

6.61 As noted above, the list of inclusions serves two purposes:

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to provide guidance on the content of the general definition;

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to include products which it is considered should be regulated under the regime notwithstanding that they do not fall within the general definition.

6.62 That is, it is not intended to be a comprehensive list and it may expand upon the general definition.

Security

6.63 A new definition of security is provided for the purposes of Chapter 7 (see definition of security in proposed section 761A). It is based on the new definition inserted by the CLERP Act in subsection 92(3) of the Corporations Law. However, it excludes interests in registered managed investment schemes. This approach has been taken in light of the fact that shares and debentures will be subject to a different disclosure regime under Chapter 6D than will interests in registered managed investment schemes, which will be subject to the disclosure regime outlined in Chapter 7.9 (see discussion in Part 14 of this Explanatory Memorandum).

6.64 The other significant difference between the definition of security under proposed section 761A and the existing definitions in section 92 is that it will no longer include options over securities, other than options over unissued securities. The effect of this is that products such as many warrants will no longer fall within the definition of security, but instead will fall within the definition of derivative (see discussion below). This means that most warrants and other options over securities will be subject to the Part 7.9 disclosure regime, rather than the disclosure regime in Chapter 6D. Regulations under the disclosure provisions will be used to ensure that all warrants, including those that will remain within the definition of security, will be subject to the Part 7.9 disclosure regime.

6.65 The definition of security will also replace the definition in subsection 92(3) for the purposes of Chapter 6D. The subsection 92(3) definition will continue to apply for the purposes of Chapters 6 to 6CA inclusive. This has been done on the basis that it is appropriate that the takeovers provisions continue to apply to managed investments and to options over securities.

6.66 Where necessary, references to securities in the remainder of Chapter 7, which should appropriately extend to managed investments have been extended to securities and managed investments.

6.67 Although the defined term security is in the singular, it is intended that references to the plural securities in Chapter 7 are also to be taken to refer to this definition, rather than the definition of securities in section 92.

6.68 The definition of security takes precedence over the definition of derivative. This is achieved by paragraph 761D(3)(d) of the definition of derivative. This means that a hybrid security and derivative product will be regarded as a security.

Managed investment product

6.69 Only interests in registered managed investment schemes will be brought within the regime (see proposed paragraph 764A(1)(b)). The regime will not apply to interests in registered managed investment schemes which are constituted by a right to participate in a retirement village scheme (see definition of excluded security in section 9 of the proposed Corporations Act). Proposed paragraph 764A(1)(b) also brings within the regime legal or equitable rights or interests and options to acquire interests in registered schemes.

6.70 Interests in managed investment schemes operated outside this jurisdiction that would have to be registered if they were operated in this jurisdiction will also be brought within the regime (proposed paragraph 764A(l)). Similarly, interests in managed investment schemes operated outside this jurisdiction that would not have to be registered if they were operated in this jurisdiction are specifically excluded from the regime (proposed paragraph 765A(s)). This also includes legal or equitable rights or interests and options to acquire interests in such schemes.

6.71 While as a general rule options to acquire interests in registered schemes are of themselves interests in a scheme by virtue of the definition of interest in section 9 of the proposed Corporations Act, proposed subparagraph 764A(1)(b)(iii) has been included to cover the rare circumstance where the option is created by a person having a right to be issued interests who is not the responsible entity or their associate.

Derivatives

6.72 The definition of derivative in proposed section 761D has been formulated to replace the existing definition of futures contract in section 72 of the proposed Corporations Act. As recommended by CASAC in its report entitled Regulation of On-exchange and OTC Derivatives Markets the definition focuses on the functions or commercial nature of derivatives rather than trying to identify each product that will be regarded as a derivative. The definition proposed by CASAC in its report has been used in developing the definition in proposed section 761D.

6.73 Features of the definition of derivative to note are:

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under the arrangement a person must or may be required to provide consideration at some future time. This ensures that options that otherwise fall within the definition are captured (proposed paragraph 761D(1)(a));

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the consideration is of a particular kind or kinds. This would cover those contracts that provide for cash settlement or physical delivery (proposed paragraph 761D(1)(a));

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contracts, such as spot foreign exchange transactions, which could vary in value as a result of movements in the exchange rate during the settlement period, will be excluded by regulation under proposed paragraph 761D(1)(b);

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the definition covers all arrangements where the amount of the consideration or the value of the arrangement varies by reference to something else (of any nature whatsoever and whether deliverable or not), including but not limited to a commodity (proposed paragraph 761D(1)(c));

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it encompasses arrangements under which both the amount of the consideration or the valueof the arrangement varies by reference to something else. This ensures that the definition covers deliverable options and futures contacts under which the consideration remains the same but the value of the arrangement varies by reference to something else (proposed paragraph 761D(1)(c));

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all consideration, including initial or periodic consideration, the amount of which was fixed at the time the arrangement was entered into, is taken into account, ensuring that options under which the obligation to pay the other party a variable amount only arises on the occurrence of a future contingent event.

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proposed paragraph 761D(3)(a) excludes from the regime a range of transactions involving the future delivery of something, including such things as contracts for the sale of land with a three month settlement period, while bringing within the regime those forward rate agreements that should be regarded as derivatives, because they are being used for hedging or speculative purposes. This is a difficult dividing line to draw as much depends on the intentions of the particular parties concerned. The existing Corporations Law seeks to deal with this issue by the concept of the likelihood of the agreement being settled other than by delivery (see definition of eligible commodity agreement in section 9 of the Corporations Law). However, CASAC explicitly rejected this test on the basis that the unlikely requirement was not clear and some futures contracts such as deliverable share futures may not be likely to be closed out. Proposed section 761D seeks to address this issue by:

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applying the relevant exclusion to tangible property only. It would not therefore apply to a deliverable share or bank bill future, as the underlying property is intangible (proposed subparagraph 761D(3)(a)(i));

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rather than focussing on the mandatory delivery aspect, it looks to whether the arrangement can settled by cash or by set-off between the parties. If the arrangement relates to tangible property and can not be cash settled, it will fall outside the definition of derivative (proposed subparagraph 761D(3)(a)(ii));

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contracts which provide for some top-up of cash in the event that tangible property does not meet the standard for delivery would none the less be excluded from the definition as a result of the reference to wholly settled by cash in proposed subparagraph 761D(3)(a)(ii);

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looking to the wider context in which the arrangement is made and recognising that while a contract on its face appears to require delivery of tangible property, market practice or the rules of a market or clearing and settlement facility mean thatdelivery isnot mandatory, but that the contact can be closed out by entering into an offsetting transaction (proposed subparagraph 761D(3)(a)(iii)).

•

The definition covers all options other than:

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options over unissued shares, which fall within the definition of security (proposed paragraph 761D(3)(c));

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options over tangible property which do not allow for cash settlement. Such options would fall within the exclusion in proposed paragraph 761D(3)(a); and

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any other options prescribed by regulations (proposed paragraph 761D(3)(d) allows regulations to exclude things from the definition of derivative).

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Proposed subsection 761D(4) takes out of the definition of derivative arrangements that only vary by reference to a general inflation index. This is intended to take outside the definition arrangements that would otherwise be derivatives merely because they have an inflation clause in them.

Insurance

6.74 Proposed section 761A contains three definitions that are relevant to the products distributed by the insurance industry:

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general insurance product - this is defined in proposed paragraph 764A(1)(d) as a contract of insurance that is not a life policy or a sinking fund policy within the meaning of the Life Insurance Act 1995 (Life Insurance Act);

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life risk insurance product - this is defined in proposed paragraph 764A(1)(e) as a life policy or sinking fund policy within the meaning of the Life Insurance Act that is a contract of insurance. Following amendments made to the Life Insurance Act by the Financial Sector Reform (Amendments and Transitional Provisions) Act (No. 1) 1999 , this would include such products issued by a friendly society;

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investment life insurance product - this is defined in proposed paragraph 764A(1)(f) as a life policy or a sinking fund policy within the meaning of the Life Insurance Act that is not a contract of insurance. This would pick up paragraphs (f) and (g) of the definition of life policy in section 9 of the Life Insurance Act. It would also include such products issued by a friendly society.

6.75 Each of these categories of insurance is taken not to include:

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benefits provided by an association of employees that is an organisation for the purposes of the Workplace Relations Act 1996 ;

•

superannuation benefits, pensions and payments to employees on retirement, disability or death provided by an employer or by employees as outlined in subsection 11(3) of the Life Insurance Act;

•

funeral benefits;

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policies issued by an employer to an employee.

Superannuation products

6.76 The regime will apply to superannuation interests within the meaning of the SIS Act (proposed paragraph 764A(1)(g)). Under that Act a superannuation interest means a beneficial interest in a superannuation entity and a superannuation entity means:

•

a regulated superannuation fund;

•

an approved deposit fund; or

•

a pooled superannuation trust (see section 10 of the SIS Act).

6.77 There are regulation-making powers in a number of parts of the regime which will enable the class of superannuation interest to which the particular provisions are to apply to be modified (see, for example, proposed section 1020G in relation to product disclosure).

6.78 The definition of financial product will include self managed superannuation funds as defined by section 17A of the SIS Act. However, such funds will be excluded from the licensing and conduct and disclosure obligations in Parts 7.6-7.8 of the FSR Bill by regulation. They will be subject to the product disclosure provisions in Part 7.9. The disclosure requirements for such funds will be detailed in the regulations as they currently are under the SIS Act. The Australian Taxation Office will continue to have administrative responsibility for self managed funds. This will be provided for in consequential amendments in subsequent legislation.

Foreign currency transactions

6.79 Proposed paragraph 764A(1)(k) includes within the definition of financial product foreign currency transactions where currency is not immediately exchanged, in recognition of the risk associated with the settlement period that typically characterises such transactions. It will also enable Australia to implement any recommendations that might flow out of the Financial Stability Forum (such as requiring disclosure of foreign exchange positions or the possible introduction of a code of practice for market conduct in this area). Where such transactions would fall within the definition of derivative, they will be regarded as derivatives.

6.80 Thus only pure money changing transactions will not be regarded as financial products for the purposes of proposed Chapter 7 on the basis that the only issues relevant to the consumer are, what is the exchange rate and how much is being charged for the service of exchanging it. The consumer knows up-front what they are receiving and there are no lags between entering the contract and receiving the benefits of the contract. These transactions will, however, be subject to the general consumer protection provisions contained in Division 2 of Part 2 of the proposed ASIC Act.

Other specific inclusions

6.81 Also specifically included are the following products:

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retirement savings accounts (RSAs);

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deposit-taking facilities made available by an authorised deposit-taking institution (ADI). However, consistent with the coverage of the Banking Act, a facility that is used for state banking is specifically excluded (see proposed paragraph 765A(1)(s));

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a debenture, stock or bond issued or proposed to be issued by a government. It should be noted, however, that existing Chapter 7 of the Corporations Law does not bind the Crown in right of a State or Territory, of the Commonwealth or of Norfolk Island (see subsection 5A(4) of the proposed Corporations Act). It is intended that the effect of this provision in relation to debentures, stocks or bonds issued by a government will be continued under the new Chapter 7; and

•

something declared by the regulations to be a financial product.

Specific exclusions

6.82 Proposed section 765A outlines the products that are specifically excluded from the regime. It applies whether the products fall within either the general definition or the list of specific inclusions. Additional products may be excluded by regulation or by ASIC (proposed paragraphs 765A(1)(y) and (z)).

Exclusion of credit

6.83 Credit facilities are not covered under the definition of financial product. To the extent that such facilities are consumer credit, they will be regulated under the State-based UCCC regime. All credit will also be subject to the general consumer protection provisions in Division 2 of Part 2 of the proposed ASIC Act (see discussion above).

6.84 Although credit is not specifically included in the regime either by the general definition or the list of specific inclusions, it is possible that certain credit arrangements could have fallen within elements of the general definition. For example, fixed rate loans could have been regarded as a facility for managing a financial risk and credit cards would have been facilities for the making of non-cash payments. For this reason credit facilities are specifically excluded from the definition of financial product (proposed subparagraph 765A(1)(h)(i)). The regulations will define what is a credit facility for the purposes of the provisions. Generally any facility that would be regarded as credit (and not just consumer credit) for the purposes of the UCCC will be prescribed by the regulations.

6.85 In addition to excluding credit facilities, the Bill also excludes facilities for the making of non-cash payments if payments made using the facility are debited to a credit facility prescribed by the regulations (proposed subparagraph 765A(1)(h)(ii)). This is intended to exclude, for example, payments made through a bill payment facility that are effected by using a credit card. This is in recognition of the fact that the credit card facility itself would not be subject to the regime, so any associated non-cash payment facility should also be excluded. However, any payments made through such a facility that are debited, for example, from a deposit account, would be covered by the regime as such accounts come within the regime.

Wrap accounts

6.86 Wrap accounts, which are arrangements under which a number of products are provided together (with or without choices) to a person along with administrative services in relation to those products, are not of themselves regarded as a financial product. Rather, each product offered under the wrap account is regarded as a separate financial product.

6.87 It is intended that services offered by the wrap account provider come within the definition of financial services business. The outcome of this approach is that a wrap account provider will be required to be licensed and will have to provide a Financial Services Guide in relation to the services that it offers.

Definition of financial service

6.88 Proposed Division 4 of the Bill describes what amounts to the provision of a financial service. This is a key definition in the Bill as a person who provides financial services is generally taken to carry on a financial services business, and therefore requires an Australian financial services licence in order to provide the relevant service(s).

When does a person provide a financial service?

6.89 Under proposed section 766A, a person provides a financial service if they:

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provide financial product advice;

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deal in a financial product;

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make a market for a financial product;

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operate a registered scheme;

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provide a custodial or depository service; or

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engage in any other conduct prescribed by the regulations for the purposes of this provision.

6.90 Proposed section 766A makes it clear that a person does not provide financial advice where the conduct is carried out in the course of work ordinarily done by clerks or cashiers.

6.91 Regulations may be made under proposed subsection 766A(2) to set out the circumstances in which persons are taken to provide, or not to provide, a financial service, including the situation where a person facilitates the provision of a financial service (for example, by publishing information).

Financial product advice

6.92 Financial product advice is defined in proposed section 766B to mean a recommendation, a statement of opinion, or a report of either of those things, which is intended to influence, or which could reasonably be regarded as being intended to influence, a person in making a decision in relation to a particular financial product, a class of products or an interest in such products.

6.93 However, financial product advice does not include anything in an exempt document, which is defined in proposed subsection 766B(6) to mean a document prepared in accordance with Chapter 7 (other than a document prescribed by the regulations for the purposed of this subsection), or any other document prescribed by the regulations for the purposes of this subsection. This exception will therefore cover any advice given in a Financial Services Guide, a Statement of Advice and a Product Disclosure Statement.

6.94 A further exception under proposed subsection 766B(5) is advice given by a lawyer in their professional capacity on legal issues.

6.95 There are two types of financial product advice: personal advice and general advice. Different disclosure requirements apply depending on whether advice is personal or general (proposed Part 7.7 of the Bill).

6.96 Personal advice is defined in proposed subsection 766B(3) as financial product advice given to a person where the provider of advice has considered the objectives, financial situation and needs of the person, or where the person might reasonably expect that the provider has considered these matters.

6.97 General advice is financial product advice that is not personal advice, according to proposed subsection 766B(4).

Dealing in a financial product

6.98 Dealing in a financial product is defined in proposed section 766C as applying for or acquiring, issuing, underwriting (in relation to securities or managed investments), varying or disposing of a financial product, or arranging for a person to engage in this conduct.

6.99 A person is taken not to deal (and therefore not to be providing a financial service) where:

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the person deals in a product on their own behalf. The exception to this is where the person is an issuer of financial products and the dealing is in relation to one or more of those products (proposed subsection 766C(3)).

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the person is a government, local government authority, public authority, or instrumentality or agent of the Crown and issues debentures, stocks or bonds, or deals only in securities relating to that entity (proposed subsection 766C(4)).

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the person is a body corporate or unincorporated body and the relevant transactions relate only to securities of that entity. However, these bodies are caught where they carry on an investment business and, in the course of the business, invest funds after an offer to the public (proposed subsections 766C(4), (5)).

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the person is a sub-underwriter and the relevant transaction is an issue of shares relating only to the sub-underwriting (proposed subsection 766C(6)).

•

the conduct is prescribed by the regulations as not amounting to dealing in a financial product.

Make a market for a financial product

6.100 A person makes a market for a financial product if they regularly state the prices at which they propose to acquire or dispose of financial products on their own behalf, and other persons have a reasonable expectation that they will be able to regularly effect transactions at the stated prices, and the actions of the person do not constitute operating a financial market because of the effect of subsection 767A(2)(a) (proposed section 766D).

Operate a registered scheme

6.101 Proposed subsection 766A(4) provides that a person is not operating a registered scheme merely because they are acting as agent or employee of another person, or taking steps to wind up the scheme.

Provide a custodial or depository service

6.102 Custodial and depository services have been included in the new regime to ensure that consumers of these services receive sufficient disclosure to make informed decisions about whether to use the services, and can be confident that service providers are competent, and have adequate compensation arrangements in place and provide access to dispute resolution procedure for retail clients. Custodial and depository services have also been included for market integrity reasons, to ensure that service providers have appropriate risk management procedures in place.

6.103 However, there are many circumstances in which client assets are entrusted to third parties where this level of regulation would not be justifiable, for example where a consumers assets are held in a bank safe deposit box. Further, where a person merely holds the assets of a managed investment scheme this level of regulation is not justified since the person holding the assets is acting under the direction of the responsible entity of the scheme. The definition therefore only covers situations where a service provider both possesses or controls client assets and provides administrative functions in relation to those assets.

6.104 Under proposed section 766E, a person provides a custodial or depository service where, under an arrangement with a client, they have possession or control of the clients assets in connection with the person providing a financial product to the client and they:

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settle transactions relating to the assets;

•

collect or distribute dividends or other pecuniary benefits derived from the assets;

•

pay tax or other costs associated with the assets;

•

exercise rights, for example voting rights, attached to or derived from the assets; or

•

perform any other function necessary or incidental to the safeguarding or administration of the assets. It is anticipated that this would include record-keeping and reporting functions.

6.105 A person also provides a custodial or depository service where they agree or undertake to provide such a service, or arrange for a third party to provide such a service to a client (proposed subsection 766E(2)).

6.106 Under proposed subsection 766E(3), the following conduct does not amount to providing a custodial or depository service:

•

the operation of a clearing and settlement facility;

•

the operation of a registered managed investment scheme;

•

the operation of a regulated superannuation fund, an approved deposit fund or a pooled superannuation trust;

•

the provision of services to a related body corporate;

•

any other conduct prescribed by the regulations.

Financial services business

6.107 Financial services business is defined in proposed section 761A as meaning a business of providing financial services. In working out whether someone carries on a financial services business, regard should be had to Division 3 of Part 1.2 of the proposed Corporations Act. For the purposes of proposed Chapter 7, paragraph 21(3)(e) in that Division will not apply.

6.108 The common law meaning of carrying on a business encompassing elements of system, repetition and continuity suggests that one-off transactions relating to the provision of financial services and financial products are unlikely to be caught by this regime. So, for example, a one-off issue of securities would be unlikely to fall within the definition of carrying on a financial services business.

General provisions relating to civil and criminal liability

General approach to offences in the Bill

6.109 A range of mechanisms will be available to ensure that provisions in the FSR Bill can be effectively and appropriately enforced. Depending of the nature of the provision, these may include one or more of: a prosecution for an offence; a civil penalty; injunctive action (particularly the wide powers available to ASIC under proposed section 1101B), as well as the ability of ASIC to impose conditions on, suspend or cancel a licence. These last powers relating to licences are particularly relevant to the proposed Chapter 7 as most of the offences apply to people who hold either financial services, market or clearing and settlement facility licences. In some circumstances, people may also be able to take civil action to recover loss or damage incurred as the result of another persons contravention of a provision.

6.110 In determining which provisions should be subject to criminal liability and the nature of these offences including the appropriate fault elements, application of strict liability and penalties, consideration has been given to other types of enforcement action that may be available.

How offences are created

6.111 Offences for contraventions of provisions in the Bill are created either through the operation of subsection 1311(1) or by provisions in a specific enforcement related Division at the end of a Part (this approach is taken in Parts 7.7, 7.8 and 7.9). To ensure that it is clear when a provision is subject to a criminal penalty, there are provisions at the beginning of these Parts (such as proposed section 940D) indicating that this approach has been taken. In addition, notes have been placed under all provisions where offences are created through subsection 1311(1).

6.112 Penalties for all offences will be contained in Schedule 3. In determining appropriate penalties, those for similar offences elsewhere in the existing Corporations Law were taken into account.

6.113 It is proposed that Chapter 7 will be included in the list of provisions in subsection 1311(1A) to which section 1311(1) does not apply unless there is a specific penalty listed in Schedule 3 (Schedule 1, Part 3, Item 29). The result of this will be that unlike the other Parts of the proposed Corporations Act, the only offences will be those created specifically by the provisions themselves or through the insertion of a penalty into Schedule 3.

6.114 The proposed Chapter 7 places an increased emphasis on regulations so as to maintain the flexibility necessary for the new regime. Therefore, it is proposed to increase the maximum penalty for an offence contained in regulations from $1000 to 50 penalty units. This will ensure that regulations which create obligations can also create offences with an appropriate penalty for their contravention.

Application of Criminal Code

6.115 The Criminal Code will apply on commencement to all offences based on provisions in the proposed Chapter 7, that is, all offences created by the provision itself or created through the operation of subsection 1311(1) or section 1314 (continuing offences), (see proposed definition of offence based on (Item 250 of Schedule 1, Part 2)). Therefore, in most instances the default fault elements specified in the Criminal Code of intention in relation to conduct and recklessness in relation to results or circumstances will be implied into offences.

Responsibility for conduct of other people

6.116 The proposed Chapter 7 contains a provision that sets out when a person is responsible for the conduct of other people (proposed section 769B), it has effect instead of Part 2.5 of the Criminal Code which provides a default rule dealing with corporate criminal responsibility.

6.117 This provision is based on section 762 of the existing Corporations Law. It applies in relation to proposed subsection 769B(10) prosecutions for offences, proceedings for civil penalty orders or civil actions under Part 9.4B, and proceedings under Chapter 9 where these are related to provisions of the proposed Chapter 7.

6.118 It provides for the situations where:

•

conduct by a person is attributed to a body corporate (proposed subsection (1)), for example, the conduct of an employee of a company where that person is acting within their actual authority is taken to be conduct of that company;

•

conduct by a person in relation to another person is attributed to a body corporate (proposed subsection (2)), for example, if a person gives money to an employee of a company that money is taken to have been given to the company itself;

•

the state of mind of a body corporate is derived from the state of mind of persons associated with that body corporate (proposed subsection (3)), for example, if a director of a company acting within their actual authority knows something, then the company is also taken to know that thing.

6.119 Proposed subsections 769B(4), (5) and (6) similarly deal with the situations where a person (other than a body corporate) has employees or agents, and conduct done by or in relation to those people is taken to be done by or in relation to that natural person, and also deals with the circumstances when that person is taken to have a state of mind that an employee or agent of the person has.

6.120 Proposed subsection 769B (7) excludes Part 7.7 from these general rules where it concerns the provision of a financial service by an authorised representative of a financial services licensee. This is necessary as Part 7.7 contains special rules about the liability of authorised representatives and licensees for a failure by an authorised representative to comply with a provision of that Part. Similarly, subsection (8) excludes Division 2 of Part 7.9 from these general rules to the extent that it relates to the liability of one regulated person for the actions of another regulated person, as that Part contains specific provisions dealing with that situation.

ASIC Exemption and Modification Provisions

6.121 In the Bill there are a number of proposed provisions that give ASIC the power to make exemptions or modifications to proposed Chapter 7 (for example, proposed sections 951B and 1020F). These provisions contain a requirement that ASIC must notify a person in writing about a modification or make it available on the Internet before such a modification 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.

6.122 However, in proposed section 798D, dealing with exemptions for self-listing licensees, a contravention of an exemption is an offence, so that in that provision the notice requirement extends to both modifications and exemptions. In addition, as that provision relates to exemptions and modifications in relation to market licensees, it is appropriate that the notification has to be in writing to individual licensees. The scope of the provision means that this would not be an overly onerous requirement on ASIC.

6.123 These proposed 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.