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

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:

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

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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

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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:

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

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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:

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name and address of the borrowing company;

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name and address of the trustee;

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name of the trust to which it has been appointed;

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

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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]