House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Revenue and Assistant Treasurer, the Hon Peter Dutton MP)

General outline and financial impact

Overview

The Financial Sector Legislation Amendment (Discretionary Mutual Funds and Direct Offshore Foreign Insurers) Bill 2007 (the Bill) implements the approach to the regulation of DMFs and DOFIs announced by the Minister for Revenue and Assistant Treasurer on 3 May 2007.

Under the approach, DOFIs will be prudentially regulated under the Insurance Act. DMFs will not be prudentially regulated but information will be collected to determine the nature and scope of their operations.

The Bill addresses an outstanding HIH Royal Commissioner's recommendation and a regulatory gap identified in the International Monetary Fund's 2006 Financial Sector Assessment Programme for Australia.

The Bill also makes a minor amendment to support changes made by the Corporations (National Guarantee Fund Levies) Amendment Bill 2007 (the NGF Bill). The NGF Bill will impose a cap on levies payable for the benefit of the NGF.

1. Discretionary Mutual Funds

The Bill introduces a regime for the collection of information on DMFs. This will be complemented by enhanced disclosure requirements under the Corporations Regulations.

Information will be collected on both the nature and scope of DMF business.

APRA will collect information on the nature and scope of DMFs' business and the role of DMFs in the Australian risk management market. This collection will occur through an amendment to FSCODA.

ASIC will collect information from AFSL holders and authorised representatives, who deal in DMF products, on the business they are placing with DMFs. This information will be collected under an existing provision in the Corporations Act through an amendment to the Corporations Regulations.

Information collected by the regulators will be used to review within three years the need to prudentially regulate DMFs.

Disclosure requirements will be strengthened through the Corporations Regulations to require DMFs to disclose the key characteristics of their product to both prospective retail and wholesale clients.

Date of effect : These amendments will commence on the day after Royal Assent.

Proposal announced : The proposals were announced by the Minister for Revenue and Assistant Treasurer on 3 May 2007.

Financial impact : It is expected that there will be minor implementation and on-going costs for APRA and ASIC, from the measures in the Bill.

Compliance cost impact : The disclosure and information collection requirements will impose a compliance cost on DMFs. However, these costs are likely to be minimal as DMFs consulted have indicated that they already disclose the unique features of their product to most of their clients and they already collect much of the information that will be sought from them.

Summary of regulation impact statement : Discretionary Mutual Funds

Impact : The measures contained in this Bill will impact on DMFs, AFSL holders and authorised representatives (financial intermediaries) who deal in DMF products, and the regulators, APRA and ASIC.

Main points :

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DMFs will have slightly higher administration costs as they will be required to provide information to APRA. They will also be required to disclose to prospective retail and wholesale clients written information on the key characteristics of the DMF product. These costs may be passed on to DMF members. However, DMFs have indicated that they already provide the information on the key characteristics of the product to the majority of their clients and they collect information on the business they are writing.

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It will allow some DMFs clients to make their risk management decisions based on disclosed information of the costs and benefits of using a DMF product.

2. Direct Offshore Foreign Insurers

The Bill strengthens and clarifies the definition 'insurance business' in the Insurance Act to capture DOFIs that carry on insurance business in Australia either directly or through the actions of another (for example, an insurance agent or broker).

As a result, DOFIs that fit within this expanded definition will be required to be authorised under the Insurance Act. As authorised general insurers, they will be required to comply with Australia's general insurance standards including having a presence and assets in Australia.

Foreign reinsurers are not captured by the expanded definition and, hence, not subject to regulation under the Insurance Act unless they choose to establish a branch or subsidiary in Australia. Lloyd's underwriters are not captured under this expanded definition, but they will remain subject to regulation under Part VII of the Insurance Act.

The Bill includes a regulation making power that will enable limited exemptions to be made under the Insurance Regulations to allow risks that cannot be placed through an authorised insurer to be placed with insurers not authorised in Australia.

The general insurance prudential standards made under the Insurance Act will be modified by APRA to take account of the risk profiles of the different categories of authorised insurers. The modifications of the general insurance prudential standards will be risk-focused.

To ensure the regulation of DOFIs is effective, APRA has been given additional enforcement powers in this Bill. APRA will now be able to investigate persons it believes are carrying on insurance business without being authorised and those persons aiding, abetting, counselling or procuring this activity. These investigation powers include a power to access the premises of persons and a power to gather information from persons under investigation.

APRA will have the power to seek an injunction from the Federal Court of Australia restricting unauthorised activity.

To complement these changes, the Bill includes a prohibition in the Corporations Act on AFSL holders and authorised representatives from dealing in a general insurance product, unless it is from an authorised insurer, a Lloyd's underwriter or subject to an exemption.

Under the Corporations Act, information will be collected from AFSL holders and authorised representatives on business placed with insurers that are not authorised in Australia.

Date of effect : These amendments will commence on 1 July 2008.

Proposal announced : The proposals were announced by the Minister for Revenue and Assistant Treasurer on 3 May 2007.

Financial impact : It is expected that APRA and ASIC will incur minor implementation costs.

Compliance cost impact : DOFIs will be required to become authorised under the Insurance Act and comply with Australia's prudential regime if they wish to carry on insurance business in Australia.

Australian financial service licence holders and authorised representatives who deal in general insurance products will be required to place their client's insurance risks with an Australian-authorised insurer unless the risk is one for which an exemption is granted. Where an exemption is in place, AFSL holders and authorised representatives will be able to place that business with an overseas insurer.

Existing authorised insurers will be subject to the modified prudential standards. However, the proposed prudential standards will not impose a greater cost on existing authorised insurers and for some, depending on their risk profile, may result in a lowering of some prudential requirements.

Summary of regulation impact statement: Direct Offshore Foreign Insurers

Impact : The measures contained in this Bill will affect DOFIs, Australian insureds that use DOFIs, AFSL holders and authorised representatives who deal in general insurance products (financial intermediaries), Australian authorised insurers, and APRA and ASIC.

Main points :

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Under the proposed approach, unless an exemption applies, DOFIs will be required to become authorised under the Insurance Act or cease operating in the Australian market. However, APRA, in applying Australia's prudential standards, will take into consideration the risk profile of the DOFI.

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At a minimum all DOFIs that operate in Australia will be required to have a presence in Australia and keep assets in Australia that meet the necessary capital requirements. This will enable Australian policyholders to access the Australian assets in the event that the DOFI fails.

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This may have an impact on Australian insureds, as some DOFIs may choose to cease writing Australian business rather than becoming authorised.

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At the same time, there will be an exemption for those entities that cannot obtain appropriate insurance through an authorised insurer, allowing those Australian insureds to continue to access overseas insurers.

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Existing authorised insurers will also be subject to the modified prudential standards. However, the proposed prudential standards will not impose a greater cost on existing authorised insurers and for some, depending on their risk profile, may result in lower prudential regulatory requirements.

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Australian financial service licence holders and authorised representatives who deal in general insurance products will be unable to place risks with unauthorised DOFIs unless an exemption applies.

3. Capping of Levies - National Guarantee Fund

The NGF Bill imposes a cap on levies payable for the benefit of the NGF in any financial year, equal to the minimum amount of the National Guarantee Fund (NGF).

The NGF provides investor protection for certain transactions on the Australian Securities Exchange (ASX). Levies are able to be collected when the fund falls below the amount required to be retained in the fund. This amount is the 'minimum amount' of the fund set through the Corporations Act.

The change provides greater certainty about the global liability of the ASX and market participants to refill the National Guarantee Fund and removes this potential for unlimited liability to refill the NGF.

The Bill also makes a minor change to the Corporations Act to support the NGF Bill. The NGF Bill is therefore included with the Bill as a package of reforms, noting that the capping of levies is unrelated to the reforms dealing with DOFIs and DMFs.

Date of effect : The amendments will commence on the 28th day after the day the Act receives Royal Assent.

Financial impact : There is no financial impact.

Compliance cost impact : The changes reduce the complexity of doing business.