House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Jim Chalmers MP)

Attachment 1: Impact Analysis - Strengthening Australia's Financial Market Infrastructure regulatory framework

Financial Market Infrastructure Regulatory Reforms, 2020 Advice to Government from the Council of Financial Regulators

Executive Summary

Introduction

Financial market infrastructures (FMIs) are the key entities that enable, facilitate and support trading in Australia's capital markets. FMIs include financial market operators, benchmark administrators, clearing and settlement facilities and derivative trade repositories. The financial system's reliance upon FMIs, particularly central counterparties (CCPs), has increased significantly following the 2008 crisis as a result of reforms intended to reduce systemic risk. Today, FMIs in Australia support transactions in securities with a total annual value of $18 trillion and derivatives with a total annual notional value of $185 trillion. A disruption to the orderly provision of FMI services could cause a disruption to the wider financial system, which may have large economic costs.

FMIs face a wide variety of risks. The 2008 crisis illustrated the financial and counterparty risks to which financial institutions, including FMIs, are exposed, and the importance of sound risk management to address these risks. More recently, the operational disruption and market volatility associated with the economic fallout from the coronavirus disease (COVID-19) has highlighted the potential for an unforeseen event to impact the smooth functioning of FMIs. In the most extreme cases, these risks could threaten the viability of these critical infrastructures.

As the regulators of FMIs, the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA) (together, the Regulators) need strong and dependable powers to carry out their mandates and mitigate the risk of disruption to FMI services. The Regulators currently have a range of powers with respect to FMIs. However, the options available to the Regulators to address the potential insolvency of an FMI or other severe threats to its continued operation are very limited. The proposed reforms are also needed to improve the ability of the Regulators to manage such risks ahead of any potential crises, by enhancing the day- to-day regulatory regime and introducing powers to prepare for the orderly resolution of a clearing and settlement facility. In addition, the current distribution of regulatory powers does not always reflect the responsibilities of each Regulator, and the legislation provides a number of operational powers to the Minister (which are currently delegated to ASIC).

The Council of Financial Regulators (CFR) considers that the limitations of the current framework, combined with the current heightened global risk environment and the growing systemic importance of FMIs, means that reforms to existing powers – as well as some additional powers to manage the risks associated with FMIs and promote reliability and integrity of the markets that FMIs support – are required. This has been acknowledged in a number of independent reviews including the 2014 Financial System Inquiry and the International Monetary Fund's (IMF's) 2019 Financial System Assessment Program review.

Recommendations

This advice to Government sets out the CFR's case for reform and makes 16 recommendations for regulatory reform that are intended to:

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introduce a resolution regime for licensed clearing and settlement facilities;

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strengthen the Regulators' supervisory and enforcement powers in relation to FMIs; and

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redistribute existing powers between ASIC, the RBA and the Minister to make the regulatory process more efficient and to better distinguish between operational and strategic functions.

The recommendations outlined in this advice were broadly supported by stakeholders in the recent public consultation (conducted between November 2019 and March 2020). In some cases, the recommendations have been refined to address the feedback provided during that consultation.

Should the Government proceed with the reforms, stakeholders will have the opportunity to engage further with the proposed reforms at a later stage in the process, once draft legislation to enact the reforms has been released publicly.

Financial Market Infrastructure Regulatory Reforms, 2019 Consultation Paper, Council of Financial Regulators

Executive Summary

The term financial market infrastructures (FMIs) refers to institutions that perform fundamental activities in financial markets. They include operators of financial markets, benchmark administrators, clearing and settlement facilities and derivatives trade repositories. FMIs are critical to the smooth and efficient functioning of the financial system. FMIs licensed in Australia support transactions in securities with a total annual value of $16 trillion and derivatives with a total annual value of $150 trillion. These markets turn over value equivalent to Australia's annual GDP every three business days. Securities and derivatives are used by investors and businesses in order to raise capital and finance, borrow and lend funds, invest in equities and debt securities and manage the risks associated with their activities. Investors rely on FMIs for access to transparent prices and a safe means of transacting in their investments, which include over $640 billion in superannuation assets held in Australian equities and fixed income assets. A disruption to the services provided by FMIs could have very severe consequences for the Australian financial system and to the investors and businesses that rely on FMIs.

International reforms following the 2008 financial crisis have increased both the role of FMIs in the financial system and the risks they face. Clearing and settlement facilities in particular are now critically important due to increased central clearing of over-the-counter (OTC) derivatives. OTC derivatives are widely utilised by financial institutions to manage their exposure to risk and there are now around $60 trillion (notional value) of Australian OTC derivative contracts outstanding, with a significant proportion of these centrally cleared.

This paper sets out the Council of Financial Regulator's (CFR's) proposed reforms to the regulation of FMIs. The reforms aim to ensure the effective regulation of the systems, services and facilities that underpin Australia's financial system.

The package includes changes to the licensing and supervision frameworks for financial market operators, benchmark administrators, clearing and settlement facilities and derivatives trade repositories, and a new crisis management regime for clearing and settlement facilities. These proposals aim to provide the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA) (the Regulators) with strong and effective powers to continue to fulfil their regulatory responsibilities.

The proposed reforms will address the recommendations of several reviews of Australia's financial system, which concluded that the current regulatory regime for FMIs should be enhanced to increase its effectiveness and align to international best practice. These reviews include the 2014 Financial System Inquiry, the 2019 International Monetary Fund (IMF) Financial Sector Assessment Program (FSAP) and previous work by the CFR. The reforms build on recent improvements to the regulation of authorised deposit-taking institutions (ADIs) and insurers and will help ensure the Australian economy is supported by a strong, well-functioning financial system.

This paper includes both new proposals and proposals that were the subject of previous consultation undertaken by the CFR. The CFR is primarily concerned with stakeholder feedback on new or changed reform proposals, but existing proposals are included in this paper to provide a complete picture of the proposed regulatory reform package.

Chapter 1 of this paper provides the rationale for reform and a brief overview of the current regulatory arrangements and the powers and functions of each of the Minister, ASIC and the RBA under the current legislation.

Chapter 2 outlines proposals designed to make sure the licensing regimes for relevant entities will be fit for purpose and effective into the future. The CFR proposes to change the roles of the Regulators so that operational licensing and related decisions sit with the Regulators and not the Minister. The Minister would retain powers in relation to strategic matters. This chapter also includes proposals to clarify when operators need to be licensed, and place additional responsibilities and obligations on licensees, reflecting their importance to the Australian financial system.

Chapter 3 outlines a number of proposals to enhance the supervisory powers of the Regulators. This includes enhancements to directions powers and information-gathering powers, a new rule-making power for ASIC, new arrangements in relation to changes in control of licensees, and the introduction of a fit and proper regime for key decision-makers.

Chapter 4 proposes the introduction of a resolution regime for clearing and settlement facilities, concentrating on modifications to proposals set out in an earlier consultation on this regime. Key proposals include expanding the scope of certain resolution powers to allow the resolution authority to take action in respect of related bodies corporate of a clearing and settlement facility licensee (CSFL) in resolution, and introducing resolution planning and resolvability powers. The CFR does not propose that the resolution regime will cover trade repositories at this time.

2014 Financial System Inquiry Report

Executive summary

This report responds to the objective in the Inquiry's Terms of Reference to best position Australia's financial system to meet Australia's evolving needs and support economic growth. It offers a blueprint for an efficient and resilient financial system over the next 10 to 20 years, characterised by the fair treatment of users.

The Inquiry has made 44 recommendations relating to the Australian financial system. These recommendations reflect the Inquiry's judgement and are based on evidence received by the Inquiry. The Inquiry's test has been one of public interest: the interests of individuals, businesses, the economy, taxpayers and Government.

Australia's financial system has performed well since the Wallis Inquiry and has many strong characteristics. It also has a number of weaknesses: taxation and regulatory settings distort the flow of funding to the real economy; it remains susceptible to financial shocks; superannuation is not delivering retirement incomes efficiently; unfair consumer outcomes remain prevalent; and policy settings do not focus on the benefits of competition and innovation. As a result, the system is prone to calls for more regulation.

To put these issues in context, the Overview first deals with the characteristics of Australia's economy. It then describes the characteristics of and prerequisites for a well-functioning financial system and the Inquiry's philosophy of financial regulation.

The Inquiry focuses on seven themes in this report (summarised in Guide to the Financial System Inquiry Final Report). The Overview deals with the general themes of funding the Australian economy and competition.

The Inquiry has also made recommendations on five specific themes, which comprise the next chapters of this report:

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Strengthen the economy by making the financial system more resilient.

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Lift the value of the superannuation system and retirement incomes.

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Drive economic growth and productivity through settings that promote innovation.

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Enhance confidence and trust by creating an environment in which financial firms treat customers fairly.

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Enhance regulator independence and accountability, and minimise the need for future regulation.

These recommendations seek to improve efficiency, resilience and fair treatment in the Australian financial system, allowing it to achieve its potential in supporting economic growth and enhancing standards of living for current and future generations.

Guide to the Financial System Inquiry Final Report

Overview and general themes

The Inquiry has taken into account important features of Australia's economy. Australia has an open, market-based economy and is a net importer of capital. The Australian economy faces a considerable productivity challenge, and the Australian population, like many around the world, is ageing. Finally, Australia is in the midst of one of the most ubiquitous, generally applicable technology changes the world has ever seen.

Characteristics of an effective financial system

The financial sector plays a vital role in supporting a vibrant, growing economy that improves the standard of living for all Australians. The system's ultimate purpose is to facilitate sustainable growth in the economy by meeting the financial needs of its users. The Inquiry believes the financial system will achieve this goal if it operates in a manner that is:

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Efficient: An efficient system allocates Australia's scarce financial and other resources for the greatest possible benefit to our economy, supporting growth, productivity and prosperity.

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Resilient: The financial system should adjust to changing circumstances while continuing to provide its core economic functions, even during severe shocks. Institutions in distress should be resolvable with minimal costs to depositors, policy holders, taxpayers and the real economy.

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Fair: Fair treatment occurs where participants act with integrity, honesty, transparency and non-discrimination. A market economy operates more effectively where participants enter into transactions with confidence they will be treated fairly.

Confidence and trust in the system are essential ingredients in building an efficient, resilient and fair financial system that facilitates economic growth and meets the financial needs of Australians. The Inquiry considers that all financial system participants have roles and responsibilities in engendering that confidence and trust.

The Inquiry's approach to financial system regulation

Central to the Inquiry's philosophy is the principle that the financial system should be subject and responsive to market forces, including competition.

However, competitive markets need to operate within a strong and effective legal and policy framework provided by Government. This includes predictable rule of law with strong property rights; a freely convertible floating currency and free flow of trade, investment and capital across borders; a strong fiscal position; a sound and independent monetary policy framework; and an effective, accountable and transparent government.

The Inquiry's approach to policy intervention is guided by the public interest. Given the inevitable trade-offs involved, deciding how and when policy makers should intervene in the financial system requires considerable judgement. Intervention should seek to balance efficiency, resilience and fairness in a way that builds participants' confidence and trust. Intervention should only occur where its benefits to the economy as a whole outweigh its costs, and should always seek to be proportionate and cost sensitive.

General themes

The Inquiry identified two general themes where there is significant scope to improve the functioning of the financial system:

1.

Funding the Australian economy.

2.

Competition.

Funding the Australian economy

The core function of the Australian financial system is to facilitate the funding of sustainable economic growth and enhance productivity in the Australian economy. The Inquiry believes Government's role in funding markets should generally be neutral regarding the channel, direction, source and size of the flow of funds.

The Inquiry identified a number of distortions that impede the efficient market allocation of financial resources, including taxation, information imbalances and unnecessary regulation. Reducing the distortionary effects of taxation should lead the system to allocate savings (including foreign savings) more efficiently and price risk more accurately. The Inquiry has referred the identified tax issues for consideration in the Tax White Paper.

A number of the Inquiry's recommendations aim to assist small and medium-sized enterprises in obtaining better access to funding. To strengthen Australia's ability to continue to access funding, both domestically and from offshore sources, recommendations have been made to improve the resilience of the Australian financial system. More broadly, given that Australia's growing superannuation system will have an increasing influence on future funding flows, the Inquiry believes that the recommendations it has made to improve the efficiency of the superannuation system would also enhance financial system funding efficiency.

Competition

Competition and competitive markets are at the heart of the Inquiry's philosophy for the financial system. The Inquiry sees them as the primary means of supporting the system's efficiency. Although the Inquiry considers competition is generally adequate, the high concentration and increasing vertical integration in some parts of the Australian financial system has the potential to limit the benefits of competition in the future and should be proactively monitored over time.

The Inquiry's approach to encouraging competition is to seek to remove impediments to its development. The Inquiry has made recommendations to amend the regulatory system, including: narrowing the differences in risk weights in mortgage lending; considering a competitive mechanism to allocate members to more efficient superannuation funds; and ensuring regulators are more sensitive to the effects of their decisions on competition, international competitiveness and the free flow of capital.

In particular, the state of competition in the financial system should be reviewed every three years, including assessing changes in barriers to international competition.

Recommendations relating to funding and competition are listed in Table 1.

Table 1: Funding the Australian economy and competition recommendations

Chapter 1: Resilience

Historically, Australia has maintained a strong and stable financial system supported by effective stability settings. However, the Australian financial system has characteristics that give rise to particular risks, including its high interconnectivity domestically and with the rest of the world, and its dependence on importing capital. More can be done to strengthen the resilience of Australia's financial system to avoid or limit the costs of future financial crises, which can deeply damage an economy and have lasting effects on people's lives.

As the banking sector is at the core of the Australian financial system, its safety is of paramount importance. Australia should aim to have financial institutions with the strength to not only withstand plausible shocks but to continue to provide critical economic functions, such as credit and payment services, in the face of these shocks. Adhering to international regulatory norms will help ensure Australian financial institutions and markets are not disadvantaged in raising funds in international financial markets.

The Inquiry's recommendations to improve resilience aim to:

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Strengthen policy settings that lower the probability of failure, including setting Australian bank capital ratios such that they are unquestionably strong by being in the top quartile of internationally active banks.

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Reduce the costs of failure, including by ensuring authorised deposit-taking institutions maintain sufficient loss absorbing and recapitalisation capacity to allow effective resolution with limited risk to taxpayer funds — in line with international practice.

These recommendations seek to ensure that Australia's financial system remains resilient into the future, and that it continues to provide its core economic functions, even in times of financial stress. These recommendations should also produce efficiency benefits, including through reducing implicit guarantees and volatility in the economy and promoting confidence and trust.

Chapter 2: Superannuation and retirement incomes

Australia's superannuation system is large by international standards and has grown rapidly since the Wallis Inquiry, primarily as a result of Government policy settings.

An efficient superannuation system is critical to help Australia meet the economic and fiscal challenges of an ageing population. The system has considerable strengths. It plays an important role in providing long-term funding for economic activity in Australia both directly and indirectly through funding financial institutions, and it contributed to the stability of the financial system and the economy during the global financial crisis.

However, the superannuation system is not operationally efficient due to a lack of strong price-based competition. Superannuation assets are not being efficiently converted into retirement incomes due to a lack of risk pooling and over-reliance on individual account-based pensions.

The Inquiry's recommendations to strengthen the superannuation system aim to:

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Set a clear objective for the superannuation system to provide income in retirement.

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Improve long-term net returns for members by introducing a formal competitive process to allocate new workforce entrants to high-performing superannuation funds, unless the Stronger Super reforms prove effective.

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Meet the needs of retirees better by requiring superannuation trustees to pre-select a comprehensive income product in retirement for members to receive their benefits, unless members choose to take their benefits in another way.

These recommendations seek to improve the outcomes for superannuation fund members and help Australia to manage the challenges of an ageing population.

Chapter 3: Innovation

Technology-driven innovation is transforming the financial system, as evidenced by the emergence of new business models and products, and substantial investment in areas such as mobile banking, cloud computing and payment services.

Although innovation has the potential to deliver significant efficiency benefits and improve system outcomes, it also brings risks. Consumers, businesses and government can be adversely affected by new developments, which may also challenge regulatory frameworks and regulators' ability to respond.

The Inquiry believes the innovative potential of Australia's financial system and broader economy can be supported by taking action to ensure policy settings facilitate future innovation that benefits consumers, businesses and government.

The Inquiry's recommendations to facilitate innovation aim to:

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Encourage industry and government to work together to identify innovation opportunities and emerging network benefits where government may need to facilitate industry coordination and action.

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Strengthen Australia's digital identity framework through the development of a national strategy for a federated-style model of trusted digital identities.

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Remove unnecessary regulatory impediments to innovation, particularly in the payments system and in fundraising for small businesses.

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Enable the development of data-driven business models through holding a Productivity Commission Inquiry into the costs and benefits of increasing access to and improving the use of private and public sector data.

These recommendations will contribute to developing a dynamic, competitive, growth-oriented and forward-looking financial system for Australia.

Chapter 4: Consumer outcomes

Fundamental to fair treatment is the concept that financial products and services should perform in the way that consumers expect or are led to believe.

The current framework is not sufficient to deliver fair treatment to consumers. The most significant problems relate to shortcomings in disclosure and financial advice, which means some consumers are sold financial products that are not suited to their needs and circumstances. Although the regime should not be expected to prevent all consumer losses, self-regulatory and regulatory changes are needed to strengthen financial firms' accountability.

The Inquiry's recommendations to improve consumer outcomes aim to:

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Improve the design and distribution of financial products through strengthening product issuer and distributor accountability, and through implementing a new temporary product intervention power for the Australian Securities and Investments Commission (ASIC).

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Further align the interests of firms and consumers, and improve standards of financial advice, by lifting competency and increasing transparency regarding financial advice.

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Empower consumers by encouraging industry to harness technology and develop more innovative and useful forms of disclosure.

These recommendations seek to strengthen the current framework to promote consumer trust in the system and fair treatment of consumers.

Chapter 5: Regulatory system

Australia needs strong, independent and accountable regulators to help maintain confidence and trust in the financial system, thereby attracting investment and supporting growth. This requires proactive regulators with the right skills, culture, powers and funding.

Australia's regulatory architecture does not need major change; however, the Inquiry has made recommendations to improve the current arrangements. Government currently lacks a regular process that allows it to assess the overall performance of financial regulators. Regulators' funding arrangements and enforcement tools have some significant weaknesses, particularly in the case of ASIC. In addition, it is not clear whether adequate consideration is currently given to competition and efficiency in designing and applying regulation.

The Inquiry's recommendations to refine Australia's regulatory system and keep it fit for purpose aim to:

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Improve the accountability framework governing Australia's financial sector regulators by establishing a new Financial Regulator Assessment Board to review their performance annually.

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Ensure Australia's regulators have the funding, skills and regulatory tools to deliver their mandates effectively.

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Rebalance the regulatory focus towards competition by including an explicit requirement to consider competition in ASIC's mandate and conduct three-yearly external reviews of the state of competition.

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Improve the process for implementing new financial regulations.

These recommendations seek to make Australia's financial regulators more effective, adaptable and accountable.

Appendix 1: Significant matters

In addition to the recommendations in the above areas, the Inquiry has made 13 recommendations relating to other significant matters. These are contained in Appendix 1: Significant matters.

Appendix 2: Tax summary

A number of tax observations are included in Appendix 2: Tax summary for consideration by the Tax White Paper.

Recommendations

The Inquiry has made 44 recommendations relating to the Australian financial system. The nature of some recommendations warrants more in-depth discussion. These recommendations are shaded darker in the Summary of recommendations by chapter tables on the following pages. The Inquiry considers that the remaining recommendations in the body of the report can be made without providing the reader with the same depth of explanation. Recommendations contained in Appendix 1: Significant matters are only explained briefly.

Summary of recommendations by chapter

Crisis management toolkit

Recommendation 5

Complete the existing processes for strengthening crisis management powers that have been on hold pending the outcome of the Inquiry.

Description

In September 2012, the previous Government consulted on a comprehensive package, Strengthening APRA's crisis management powers. ⁶³ The CFR has also recommended separate changes to resolution arrangements and powers for FMI. ⁶⁴ In 2013, these processes were put on hold as part of a Government moratorium on significant new financial sector regulation pending the outcome of this Inquiry. Government should now resume these processes, with a view to ensuring regulators have comprehensive powers to manage crises and minimising negative spill-overs to the financial system, the broader economy and taxpayers.

The Inquiry strongly supports enhancing crisis management toolkits for regulators. It is important for the two processes to be concluded, giving due consideration to industry views on the packages.

Objectives

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Promote a resilient financial system.

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Enable the orderly resolution of distressed financial institutions.

Discussion

Problems the recommendation seeks to address

Given the importance of ADIs, insurers, superannuation funds and FMI to the functioning and stability of the financial system and economy, regulators need comprehensive powers to facilitate the orderly resolution of these institutions.

Responding to local and global changes, CFR agencies reviewed the existing legislative provisions for prudentially regulated institutions and FMI. These reviews paid close attention to international standards and developments, particularly G20 and FSB initiatives to promote resilient financial systems and frameworks that resolve financial distress, including the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions (Key Attributes). ⁶⁵ Although Australia has strong frameworks, the reviews identified gaps and areas that could be strengthened.

The Government consultation paper Strengthening APRA's crisis management powers canvassed a number of options in relation to all APRA-regulated industries. The package does not include statutory bail-in powers outlined in the Key Attributes or general structural requirements, such as ring-fencing, being pursued in some jurisdictions. It includes:

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Directions powers, including clarifying that APRA may direct a regulated institution to pre-position for resolution — that is, require changes at an institution to make it more feasible to successfully resolve that institution if it were to fail.

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Group resolution powers, including extending certain powers to authorised non-operating holding companies (NOHCs) and subsidiaries in a range of distress situations.

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Powers to assist with resolving branches of foreign banks.

The CFR recommendations for strengthening the crisis management framework for FMI included:

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Introducing a specialised resolution regime for FMI.

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Clarifying the application of location requirements for FMI operating across borders.

Since these processes were put on hold, international developments have included updates to the Key Attributes, yielding additional guidance on areas such as

cross-border information sharing, and resolving FMI and FMI participants. Some countries have also introduced structural reforms, such as mandating a form of ring-fencing, or a NOHC structure for institutions with certain risk profiles or of a certain size, with the aim of improving resolvability. These approaches emphasise reducing risks to core banking activities from more complicated and risky forms of banking, and simplifying institutions to make them more easily resolved.

Conclusion

The Inquiry believes progressing the packages would deliver a substantial net benefit. A range of resolution options — more 'tools in the toolkit' — would maximise the likelihood that a viable option will be available in any given situation to achieve an orderly resolution. The Inquiry notes the high costs associated with the disorderly failure of an institution, particularly where this creates financial system instability or the need for Government support. The Inquiry also notes that many of the proposed powers would have a limited regulatory burden in normal times.

In relation to the package of resolution powers for APRA, industry submissions largely support the package, although they raise practical and legal issues with some of the proposals. ⁶⁶

APRA's submission to the Inquiry stresses the vital role that crisis management powers play in the prudential framework. ⁶⁷ In any future crisis, these reforms would provide a wider range of tools, making it more likely that a credible, low-cost option for preventing a disorderly failure could be found, without risking taxpayer funds.

The RBA advocates for progressing the CFR proposals on FMI regulation as a matter of priority. ⁶⁸ It notes that the continuity of FMI services is critical for the financial system to function. In addition, the RBA notes that, where FMI is domiciled offshore, Australian regulators need to have sufficient influence to prevent Australian functions from being compromised in a resolution.

The Inquiry does not recommend pursuing industry-wide structural reforms such as ring-fencing. These measures can have high costs, and require changes for all institutions regardless of the institution-specific risks. Neither APRA nor the RBA nor the banking industry saw a strong case for these reforms.

Nevertheless, APRA submits that it may be beneficial to require structural changes for specific institutions in some situations, where substantial risks or significant organisational complexity may impede supervision or an orderly resolution. The powers included in the consultation package provide sufficient flexibility to do this effectively.

Given the time that has passed since the initial consultation in progressing the reform packages — in particular, the considerable international developments over this period — a view should be taken as to whether additional proposals warrant inclusion.

All proposals should go through the appropriate consultation, regulatory assessment and compliance cost assessment processes.

⁶³ Treasury 2012, Strengthening APRA's Crisis Management Powers: Consultation Paper, Commonwealth of Australia, Canberra.

⁶⁴ Stevens, G 2012, 'Review of Financial Market Infrastructure Regulation', letter to The Hon. Wayne Swan, MP, Deputy Prime Minister and Treasurer, 10 February

⁶⁵ Financial Stability Board (FSB) 2014, Key Attributes of Effective Resolution Regimes for Financial Institutions, FSB, Basel.

⁶⁶ Submissions on the consultation paper are available on the Treasury website, viewed 11 November 2014,

http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2012/APRA/ Submissions .

⁶⁷ Australian Prudential Regulation Authority 2014, Second round submission to the Financial System Inquiry, page 38.

⁶⁸ Reserve Bank of Australia 2014, First round submission to the Financial System Inquiry, page 4.

IMF Financial Sector Assessment Program, 2019 Financial System Stability Assessment (Australia)

EXECUTIVE SUMMARY

The Australian authorities have taken welcome steps to further strengthen the financial system since the previous FSAP. Bank capital requirements have been raised and applied more conservatively than minimum Basel standards. Funding risks have been lowered. Financial supervision and systemic risk oversight have been enhanced. And the authorities have taken successful policy action to calm rapid growth in riskier segments of the mortgage market.

The system nonetheless faces challenges. Stretched real estate valuations and high household leverage pose significant macrofinancial risks. 27 years of uninterrupted growth, low inflation, low policy rates, tax incentives, and easy credit have stimulated a rise in household debt and fueled a build-up of real estate exposure in a concentrated banking system, which together with pension ('superannuation") funds dominates the large Australian financial sector. Household debt has risen by some 25 percentage points since the previous FSAP to about 190 percent of disposable income, one of the highest levels in the world. Banks continue to draw extensively on overseas wholesale funding, though reliance has declined in recent years. The ongoing Royal Commission (RC) inquiry has revealed a pattern of misconduct in the financial sector, including at the four major banks that comprise 80 percent of the system.

The major banks run similar business models, raising the vulnerability of the system to a common shock. All are heavily exposed to real estate—residential forming about 60 percent of loans, and commercial (CRE) a further 7 percentage points. Wholesale funding dependence has diminished but remains around one-third of total funding, of which nearly two-thirds is from international sources. Banks' direct international exposures are mainly to New Zealand, where subsidiaries of the four major Australian banks play a dominant role in the banking system.

Bank solvency appears relatively resilient to stress. A test of resilience to a combination of a significant slowdown in China, a severe correction in real estate valuations, and a marked tightening of global financial conditions, revealed some pressures on capital, although the 10 largest banks would all still meet regulatory minima. Liquidity pressures may arise more abruptly. Given high maturity transformation, banks' continued reliance on overseas wholesale funding leaves them exposed to global liquidity shocks.

Policy action has lowered financial stability risks. Restrictions on the growth of investor loans and the share of interest-only mortgages, as well as the introduction of stronger lending standards, appear to have led to a slowdown in mortgage credit growth, and the housing market is now cooling. Given this background, additional tightening measures do not appear warranted at this juncture, though, given prevailing vulnerabilities, the authorities should stand ready to recalibrate policies as necessary to continue to reduce systemic risk. Over time, broader tax reforms could reduce structural incentives for leveraged investment by households, including in residential real estate. Further reduction in banks' use of wholesale funding and extension of the duration of their liabilities would help to lower structural funding risks.

Australia benefits from a robust regulatory framework. Financial supervision shows generally high conformity to international best practices, although there are opportunities to close identified gaps and strengthen arrangements. Steps are recommended to bolster the independence and resourcing of the regulatory agencies, by removing constraints on their policy making powers and providing additional budgetary autonomy and flexibility.

Enforcement powers should be strengthened, and their use expanded, to support effective risk management and mitigate future misconduct. Supervisory approaches would also be enhanced by periodic in-depth reviews of banks' governance and risk management, and by improving coordination of supervision of internationally active insurance groups.

Greater formalization and transparency of the work of the Council of Financial Regulators (CFR) would further buttress the financial stability framework. While the authorities have a strong track record of addressing financial stability issues in a productive and collaborative manner, the current arrangements are informal, and there is limited transparency surrounding the work of the Council. Greater formalization could further strengthen collaboration, boost confidence in the collective work of the regulatory agencies, and guard against possible delay in addressing nascent systemic risks. The CFR is encouraged to boost transparency by publishing records of its meetings and tabling an Annual report to Parliament, highlighting the identification of systemic risks and actions taken to mitigate them.

Additional investment in data and analytical tools would strengthen financial supervision and systemic risk oversight. Relative to international experience, the assessment identified shortfalls in the granularity and consistency of data to support the analysis of supervisory and systemic risks and the formulation of policy. The CFR agencies are recommended to conduct a major review of potential data needs and implement improvements, publishing the resulting data where feasible.

Improved data would also facilitate enhancements in stress testing and support closer integration of the results into prudential supervision, crisis preparedness and policy discussions. It would also help harness the collective expertise of the Reserve Bank (RBA) and the Australia Prudential Regulation Authority (APRA) in the analysis and evaluation of policy options.

Expansion of the set of policy tools would enhance flexibility to address systemic risk and structural vulnerabilities. A 'readiness' assessment of potential policy options would enable the authorities to address the associated data requirements and tackle any legal or regulatory obstacles to their use. Priorities for review include DTI/DSTI and LTV restrictions, time-varying risk weights, as well as tools to address risks from nonbanks and from highly cyclical assets such as CRE.

Reinforcing financial crisis management arrangements is a priority. Encouraging progress has been made in strengthening APRA's resolution powers and expanding banks' recovery planning to cover additional institutions. Building on this progress, there is scope for better integration of banks' recovery planning into their risk management framework. It is also important to complete the resolution policy framework quickly, to ensure that banks expand their loss absorbency capacity to bear the costs of their own failure. Bank-specific resolution plans should be rolled out and validated swiftly. The Australian and New Zealand authorities have developed a strong and effective supervisory relationship, but there is a need to advance mutual understanding of approaches to resolution in order to establish clear cross-border bank resolution modalities. Some progress has also been made in developing a resolution framework for Financial Market Infrastructures (FMIs) and its finalization is a priority.

40. While AUSTRAC has the authority to oversee banks' AML/CFT systems, its significant reliance on banks' self-reporting of weaknesses has not always proved effective. Recent events have shown that some banks' processes for ensuring compliance with AML/CFT requirements have not worked as reported, which have resulted in failure to comply with rules and laws. AUSTRAC should enhance its supervisory approach by performing end-to-end periodic thematic reviews of AML/CFT systems particularly for major banks and should take swift formal action to address weaknesses and critical compliance issues.

E. Financial Market Infrastructures ³²

41. Financial Market Infrastructures (FMIs) in Australia generally operate reliably, and the competitive landscape has seen new entrants and competitors emerge. The Reserve Bank Information and Transfer System (RITS), operated by the RBA, is the only domestic systemically important interbank payment system. In addition, the domestically incorporated Australian Securities Exchange (ASX) group operates an integrated infrastructure including trading platforms, two central counterparties (CCPs) and two securities settlement systems (SSSs) (Figure 11). Since 2011, the ASX has faced competition from foreign infrastructures in some markets, including Chi-X for cash equities trading and the London Clearing House Limited (LCH Ltd) and the Chicago Mercantile Exchange (CME) for some over the counter (OTC) derivatives clearing.

42. FMIs are subject to strong supervisory oversight though enforcement powers should be strengthened further. Supervisory oversight of FMIs by the RBA and ASIC is well-established, with supervisory expectations importantly strengthened over the past few years. Legal and regulatory frameworks for FMIs are generally clear and transparent; and regulatory requirements sufficiently detailed due to the adoption of the PFMI and subsequent guidance. The FSAP recommends that the authorities strengthen enforcement powers for the supervision of CCPs and SSSs to promote compliance with regulatory requirements and to take corrective actions in accordance with the PFMI, as well as to promote effective competition between FMIs (given that one entity operates several systemic FMIs). Steps should also be taken to further enhance already close cooperation between domestic and foreign authorities in case of a crisis event affecting FMIs.

43. Further attention is warranted to strengthen ASX Clear's governance and risk management framework to promote compliance with the authorities' guidelines. ASX Ltd and the authorities are encouraged to consider the impact of the current governance structure on compliance with risk management requirements. Additional improvements to risk management systems should be considered to facilitate separation of house and client accounts, implementation of concentration limits on collateral, holding of adequate pre-funded liquid resources and improvements in the operation of intraday margin calls. Operational risks should also be further addressed.

44. The authorities should prioritize finalization of the special resolution regime for FMIs. Some progress has already been made. The CFR authorities are in the process of drafting legislation that establishes a resolution regime for FMIs consistent with international standards and that incorporates feedback from stakeholders on a past consultation paper. ³³ To finalize the regime, the authorities will need to address issues specific to Australia's financial market structure, such as clearing and settlement facilities that are part of a vertically-integrated exchange group, the dominance of a few domestic financial institutions and a few global banks, and issues regarding the diversity and capacity of private liquidity providers.

³³ See "Resolution Regime for Financial Market Infrastructures," Treasury, February 2015, and "Resolution Regime for Financial Market Infrastructures: Response to Consultation," CFR, November 2015.

³⁴ Australia was assessed jointly by the Financial Action Task Force (FATF) and the Asia-Pacific Group on Money Laundering. The mutual evaluation report (MER) was adopted on February 27, 2015 and published on April 21, 2015, see
http://www.fatf-gafi.org/countries/a-c/australia/documents/mer-australia-2015.html .

³⁵ FATF has upgraded Australia's ratings on seven Recommendations, see
http://www.fatf- gafi.org/media/fatf/documents/reports/fur/FUR-Australia-2018.pdf . Australia remains in the FATF's enhanced follow-up process because 14 Recommendations remain non- or partially- compliant, including several related to priority improvements identified in the MER.

³⁶ Financial intelligence is analysis derived from reports submitted to FIUs and from other information sources, aimed at assisting criminal investigations into money laundering, its underlying offences or terrorist financing by: identifying the extent of criminal networks and/or the scale of criminality; identifying and tracing the proceeds of crime, terrorist funds or any other assets that are, or may become, subject to confiscation; and developing evidence, which could be used in criminal proceedings.

IMF Financial Sector Assessment Program, 2019 Technical Note – Supervision, Oversight and Resolution Planning on Financial Market Infrastructures

EXECUTIVE SUMMARY

Financial Market Infrastructures (FMIs) in Australia generally operate reliably, and the competitive landscape has seen new entrants and competitors emerge. The Reserve Bank Information and Transfer System (RITS), operated by the Reserve Bank of Australia (RBA), is the only domestic systemically important interbank payment system. In addition, the domestically incorporated ASX Limited (ASX) group operates an integrated infrastructure including trading platforms, two central counterparties (CCPs), and two securities settlement systems (SSSs). Since 2011, the ASX has faced competition from foreign infrastructures in some markets, including Chi-X Australia Pty Ltd (Chi-X) for cash equities trading and the LCH Limited (LCH Ltd) and the Chicago Mercantile Exchange (CME) for some over the counter (OTC) derivatives clearing.

Supervision and oversight of FMIs is well-established with supervisory expectations importantly strengthened over the past few years. The Australian authorities responsible for the regulation, supervision, and oversight of FMIs are the RBA and the Australian Securities and Investments Commission (ASIC). The RBA has sole responsibility for payment systems, while ASIC and the RBA have complementary regulatory responsibilities for CCPs and SSSs. The FSAP assessment is that Clearing and Settlement (CS) facility ² supervision and oversight are strong and that the FMI legal and regulatory framework generally is clear and transparent. The adoption of the CPSS-IOSCO Principles for Financial Market Infrastructures (PFMI) and subsequent guidance has strengthened the authorities' approach with more comprehensive requirements and assessments, as well as increased diligence in following up on findings. Cooperation among the authorities is close, both domestically as well as with foreign authorities, although cooperation frameworks need to be further developed to manage FMI crisis events. The mission recommends the RBA consider updating its approach to payment systems oversight, in particular to increase the transparency around expectations for potential (privately operated) systemically important payment systems.

Enforcement powers for the supervision of CCPs and SSSs should, however, be strengthened in accordance with the PFMI. Currently, the RBA has no independent enforcement powers to underpin its oversight. The RBA may request that ASIC issue a direction to comply with the FSS or to reduce systemic risk; however, ASIC is not required to do so. Furthermore, the Minister may overrule ASIC's decision regarding whether to make or to revoke a direction. Although there is no evidence of such intervention by the Minister (and, in fact the Minister has delegated certain responsibilities to ASIC), the current legal basis for enforcing corrective actions should be strengthened with independent powers for the RBA. It also is recommended that legislation should grant ASIC and the ACCC the powers to promote fair and effective competition between FMIs, as such powers are lacking. Supervisory powers could be broadened, for example, by granting rule writing powers in addition to directions powers.

The Australian authorities have made some progress in formulating a special resolution regime for FMIs. In 2015, the Australian government issued a high-level consultation paper to establish a special resolution regime for CS facilities (and trade repositories) consistent with international standards. It requested feedback on the scope of the resolution authority, resolution and directions powers, safeguards and funding arrangements, and international cooperation. The CFR authorities are developing drafting instructions for legislation that would establish a resolution regime for FMIs.

² CCPs and SSSs jointly are called Clearing and Settlement (CS) facilities under the Australian Corporations Act 2001.

The government should prioritize finalization of its special resolution regime for domestic FMIs, since it currently lacks the necessary framework and tools to resolve an FMI. The authorities will need to address issues specific to Australia's financial market structure, such as CS facilities that are part of a vertically-integrated exchange group, the dominance of a few domestic financial institutions and a few global banks in the Australian financial market, and issues regarding the diversity and capacity of private-sector liquidity providers. This specific structure will have an important bearing on the decisions that the Australian government will have to make regarding the breadth of the authorities' powers. Important considerations include the treatment of affiliated entities within groups, including the implications for the point-of-entry strategy, and the breadth of ex-ante resolvability assessments and FMI resolution plans.

New supervisory challenges, in particular related to cyber risks and new technologies, are appropriately addressed by ASIC and the RBA; nevertheless, cyber resilience of FMIs would further benefit from industry-wide cyber tests. RITS and ASX's CS facilities are subject to regular cyber resilience assessments by the authorities against CPMI-IOSCO guidance, international standards, and good practices. Authorities could supplement these with industry-wide cyber resilience tests to gain insights into the impact of a cyber incident on the industry as a whole. With regard to distributed ledger technology (DLT) and other new technologies, ASIC's and RBA's approach includes monitoring developments and specifying expectations. Supervision of the replacement of ASX's CS systems, which uses DLT technology, can be fully addressed within the existing regulatory framework. It involves a permissioned model, where only ASX, clearing members, and issuers would be authorized to participate. Private contractual information would be available only to the transaction parties, and ASX would be the only permissioned writer to the ledger.

The FSAP's assessment of elements of ASX Clear's governance and risk management framework identified several areas where further attention is warranted. ASX Ltd and the authorities are encouraged to consider the impact of the current governance structure on compliance with CS risk management requirements, including whether a simpler structure would help meet requirements related to competition issues in the equity market more easily. The planned FMI resolution regime will also have to address the integrated functions and any resulting obstacles to the FMI's resolvability. ASX Clear's recovery plan should address its reliance on parent funding and on other group services. Further improvements to its risk management systems should be considered, such as the operational capacity to implement intraday margin calls, separate house and client accounts, implementation of concentration limits on collateral, and availability of sufficient pre-funded liquid resources before applying mechanical liquidity allocation mechanisms. Operational risks need to be further addressed in line with authorities' requirements.

Overseas Clearing and Settlement Facilities: The Australian Licensing Regime, 2015 Consultation Paper, Council of Financial Regulators

Introduction

The increasingly global nature of many financial markets, combined with regulatory reforms, has prompted increased participation by domestic financial institutions in overseas clearing and settlement (CS) facilities. A number of overseas CS facilities have also recently begun, or expressed interest in, providing CS services that may be relevant to the safe, efficient and effective functioning of the Australian financial system, or confident, fair and effective dealings in financial products by Australian CS facility users.

Alongside these developments, the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA) are receiving an increasing number of queries regarding whether certain overseas CS facilities fall within the scope of the licensing regime under Part 7.3 of the Corporations Act 2001 (Corporations Act). These queries have arisen primarily due to a lack of clarity around whether, for the purposes of the Corporations Act, an overseas CS facility is 'operating in this jurisdiction'. This is the threshold that determines whether a CS facility must be either licensed or exempted from Part 7.3 of the Corporations Act.

The Council of Financial Regulators (CFR) considers that there is a case to provide greater clarity, to the extent practicable, regarding the circumstances in which a CS facility must be either licensed in Australia or exempted from Part 7.3 of the Corporations Act. While ASIC has issued guidance that sets out a number of non-exhaustive factors that it would consider in assessing whether a CS facility is operating in this jurisdiction, ¹ greater clarity in legislation and accompanying regulation would provide increased legal certainty for overseas CS facilities and their participants.

This consultation seeks preliminary views on legislative change as part of the CFR's ongoing consideration of the cross-border regulation of CS facilities. Any legislative change will ultimately be a matter for the government to consider.

This paper proposes a new approach to assessing whether an 'overseas' CS facility (i.e. a CS facility that is not operated by a body corporate registered under Chapter 2A of the Corporations Act) must be either licensed in Australia or exempted from Part 7.3 of the Corporations Act. The proposal rests on a test of the materiality of the CS facility's connection to the Australian financial system. ASIC, in consultation with the RBA, will make a determination about whether a CS facility's activities are material for the purposes of this test. The purpose of this proposal is to promote Australian entities' access to a diverse range of CS options, both in Australia and overseas, by providing clarity to all stakeholders on the scope of the Australian CS facility licensing regime.

It is not expected that the proposed new approach would result in additional CS facilities being within the scope of Australia's CS facility licensing regime, and the rest of the Australian CS facility licensing regime would remain unchanged. The factors relevant to a consideration of the materiality of a CS facility's connection to the Australian financial system by ASIC and the RBA (together, the regulators) are already listed in ASIC's Regulatory Guide 211 – Clearing and Settlement Facilities: Australian and Overseas Operators (RG 211). Rather, the proposed new approach formalises how these factors are currently, and in the future will be, weighed in reaching judgements around regulatory scope so as to provide clarity and transparency for prospective future CS facility licence applicants.

¹ See ASIC (2012), Regulatory Guide 211 – Clearing and Settlement Facilities: Australian and Overseas Operators, December. Available at
http://asic.gov.au/regulatory-resources/find-a-document/regulatory-guides/rg-211-clearing-and-settlement- facilities-australian-and-overseas-operators/ .

Background

CS facilities are regulated in Australia under the Corporations Act in order to maintain financial system stability, reduce systemic risk and ensure CS services are provided in a fair and effective way. These objectives are the basis for the scope of the Australian CS facility licensing regime.

The Corporations Act currently provides that a CS facility must only be operated in this jurisdiction (i.e. operated in Australia) if its operator holds an Australian CS facility licence or the facility is exempt from Part 7.3 of the Corporations Act. While section 820D of the Corporations Act provides that a CS facility is taken to be operating in this jurisdiction if it is operated by a body corporate registered under Chapter 2A of the Corporations Act, it does not limit the circumstances in which a CS facility is operated in this jurisdiction. ASIC's RG 211 sets out a number of non-exhaustive factors that it would consider when assessing whether a CS facility operates in this jurisdiction. These factors are:

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the location of the CS facility's technical infrastructure

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whether the CS facility has one or more Australian users or participants

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the volume and value of transactions submitted to the CS facility by Australian users or participants

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the nature of the transactions and financial products made available, for example whether these products are denominated in Australian dollars

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whether the CS facility has entered into an arrangement with a financial market operating in Australia to provide CS services to that market.

If a CS facility is operating in this jurisdiction, its operator must apply to the Minister, through ASIC, for an Australian CS facility licence or an exemption from Part 7.3 of the Corporations Act (see Figure 1). The Corporations Act provides for two classes of Australian CS facility licence: a 'domestic' licence, granted under section 842B(1); and an 'overseas' licence, granted under section 824B(2). ² The Minister may grant an overseas licence to a CS facility operator if the requirements of section 824B(2) are met, including that the operator is authorised to operate the CS facility in the foreign country in which the principal place of business is located, and the regulatory regime in that country is sufficiently equivalent to that in Australia.

An operator can also apply to the Minister for an exemption from the requirement to hold an Australian CS facility licence (i.e. an exemption from Part 7.3 of the Corporations Act). ASIC will recommend an exemption when it is satisfied that there is no policy reason for regulating the operator of a CS facility in this jurisdiction as a licensee. ASIC will normally only advise the Minister to exempt a particular CS facility if:

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the regulatory outcomes for CS facilities are not relevant to its CS facility

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the regulatory outcomes for CS facilities are achieved without regulation under Part 7.3

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the cost of the regulation required to achieve the regulatory outcomes for CS facilities significantly outweighs the benefits of those outcomes.

² The two separate classes of Australian CS facility licence ensures the appropriate regulatory influence is accorded to CS facilities operating in this jurisdiction. For example, a systemically important CS facility with a strong domestic connection would be required to incorporate locally and hold a domestic licence, such that ASIC and the RBA would be the primary regulators. Further consideration was given to this matter in the Australian Government's February 2015 consultation paper 'Resolution Regime for Financial Market Infrastructures', available at
http:// www.treasury.gov.au/ConsultationsandReviews/Consultations/2015/Resolution-regime-for-financial-market-infrastructures .

2. Proposed Amendments

The policy intention behind Australia's CS facility licensing regime is to capture facilities with operations that have, or are expected to have, implications for the safe, efficient and effective functioning of the Australian financial system or the confident, fair and effective dealings in financial products by Australian investors; that is, to capture facilities that have a material domestic connection. It is proposed that the existing concept of operating in this jurisdiction be replaced by the concept of a material domestic connection for overseas CS facilities.

It is proposed that:

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a body corporate that is registered under Chapter 2A of the Corporations Act must only operate, or hold out that it operates, a CS facility if the body corporate has an Australian CS facility licence, or the facility is exempt from the operation of Part 7.3 ³

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a CS facility operator, other than a body corporate registered under Chapter 2A, must only operate, or hold out that it operates, a CS facility that has a material domestic connection to Australia if the CS facility operator has an Australian CS facility licence, or the facility is exempt from the operation of Part 7.3.

The test would include two components, both of which must be met for the requirement for an overseas CS facility to be either licensed or exempted from the operation of Part 7.3 of the Act (see Figure 2).

³ This has the same effect as section 820D of the Corporations Act; however, it is not linked to the concept of 'operating in this jurisdiction'.

First Component: A CS Facility's Domestic Connection

The first component of the test – a CS facility's domestic connection – would establish objectively if the operations of a CS facility were in any way connected to the Australian financial system. It is intended that this component provide a high degree of certainty for all stakeholders as to when a CS facility was out of the scope of the Australian CS facility licensing regime. The factors that would constitute a domestic connection include: the location of a CS facility's operations in Australia; the provision of CS services for financial products connected with Australia; the provision of CS services to one or more Australian participants; or having arrangements with the operator of a domestically licensed or exempted financial market or CS facility. These factors are set out in Section 5 of this paper.

This component of the test aims to ensure that CS facilities relevant to the functioning of the Australian financial system are identified as potentially within the scope of the Australian CS facility licensing regime. The materiality of these facilities' domestic connection would then be assessed under the second component of the test (described below), to establish whether they should indeed be subject to licensing (or exemption from the regime).

In defining a domestic connection for the purposes of this component of the test, the CFR has aimed to strike a balance between public policy relevance and appropriate cross-border reach. That is, the CFR has sought to ensure that the potential scope of the regime is neither too broad nor too narrow. For example, a connection that arose solely from Australian users' indirect participation in an overseas CS facility in relation to activities in non-Australian-related products would not fall within the proposed definition, on the basis that too large a number of overseas CS facilities would then potentially be within the scope of the regime. In striking this balance, the CFR has taken into account that non-participant users would be likely to be accorded the appropriate protections via the implementation of the CPMI-IOSCO Principles for Financial Market Infrastructures by the CS facility's primary regulator(s). For example, Principle 14 relating to the segregation and portability of positions of a participant's customers and the collateral provided to the CS facility with respect to those positions.

The CFR also acknowledges that this component of the test should balance the need to provide regulatory certainty for all stakeholders with the need for flexibility to account for future changes in the nature of the provision of CS services – for example, through evolution in the participation models offered by CS facilities. For this reason the CFR is seeking feedback on whether the factors constituting a domestic connection are appropriate to accommodate such future changes and whether any other factors should be considered.

A CS facility that had a domestic connection would be required to notify ASIC and the RBA.

Second Component: Materiality of a CS Facility's Domestic Connection

Where the first component of the test established whether an overseas CS facility had a domestic connection, the second component would assess the materiality of that connection. A CS facility's connection to the Australian financial system would be material if ASIC, in consultation with the RBA, is satisfied that the facility's current or expected activities were material to the safe, efficient and effective functioning of the Australian financial system or the confident, fair and effective dealings in financial products by Australian investors.

To provide further clarity to stakeholders, the circumstances in which the materiality component of the test is likely to be met and the factors that ASIC and the RBA would take into consideration could be included in Corporations Regulations, other legislative instruments and/or revised regulatory guidance. These details are set out in Section 5 of this consultation paper, and are accompanied by case studies that demonstrate how the revised test would be applied.

It is proposed that where ASIC, in consultation with the RBA, considers a CS facility's domestic connection to be material, ASIC would make a formal determination to that effect. A CS facility that had a material domestic connection would be required to have an Australian CS facility licence or be exempt from the operation of Part 7.3 of the Corporations Act. Positive decisions on the materiality of a CS facility's domestic connection will be evidenced in the advice on a CS facility's application for an Australian CS facility licence or exemption provided by ASIC and the RBA to the Minister.

This approach would ensure the appropriate regulation of all CS facilities with a connection to the Australian financial system or its users, so that an overseas CS facility with a connection to the Australian financial system that was not material is not required to be either licensed or exempted from Part 7.3 of the Corporations Act.

Under this approach, the materiality of a CS facility's connection to the Australian financial system may reflect either a single characteristic or a combination of characteristics, and it is not possible to establish definitive thresholds for materiality that would apply in all circumstances. Accordingly, this test would require the exercise of judgement by ASIC, in consultation with the RBA. This approach should provide additional clarity to all stakeholders, while also retaining necessary flexibility within the Australian CS facility licensing regime.

Overseas Clearing and Settlement Facilities: The Australian Licensing Regime, 2015 Response to Consultation, Council of Financial Regulators

Introduction and Background

In March 2015, the Council of Financial Regulators (CFR) released the consultation paper 'Overseas Clearing and Settlement Facilities: The Australian Licensing Regime'.1 The consultation paper sought stakeholder views on a proposed new approach to assessing whether an 'overseas' clearing and settlement (CS) facility (i.e. a CS facility that is not operated by a body corporate registered under Chapter 2A of the Corporations Act 2001 (the Corporations Act)) must be either licensed in Australia or exempted from Part 7.3 of the Corporations Act.

The Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA) – together, the regulators – are receiving an increasing number of queries from overseas CS facilities as to whether they fall within the scope of the licensing regime. These queries have arisen primarily due to a lack of clarity around whether an overseas CS facility is 'operating in this jurisdiction', which is the relevant test in Part 7.3 of the Corporations Act. The purpose of the proposed new approach is to promote Australian entities' access to a diverse range of CS options, both in Australia and overseas, by providing clarity and increased legal certainty to all stakeholders on the scope of the Australian CS facility licensing regime.

The proposal rests on a two component test of the materiality of the CS facility's connection to the Australian financial system. An overseas CS facility will be required to be licensed (or formally exempted from licensing) if, and only if, it has a material domestic connection. The policy intention is to capture only facilities with operations that have, or are expected to have, implications for the safe, efficient and effective functioning of the Australian financial system or the confident, fair and effective dealings in financial products by Australian investors. At the same time, the approach aims to strike an appropriate balance between public policy relevance and appropriate cross-border reach.

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First component: A CS facility's domestic connection. The first component of the test would establish objectively if the operations of a CS facility were in any way connected to the Australian financial system. It is intended that this component provide a high degree of certainty for all stakeholders as to when a CS facility is not within the scope of the Australian CS facility licensing regime. The factors that would constitute a domestic connection include: the location of a CS facility's operations in Australia; the provision of CS services for financial products connected with Australia; the provision of CS services to one or more Australian participants; or having arrangements with the operator of a domestically licensed or exempted financial market or CS facility.

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Second component: Materiality of a CS facility's domestic connection. Where the first component of the test established that an overseas CS facility had a domestic connection, the second component would assess the materiality of that connection. A CS facility's connection to the Australian financial system would be material if ASIC, in consultation with the RBA, was satisfied that the facility's current or expected activities were material to the safe, efficient and effective functioning of the Australian financial system or the confident, fair and effective dealings in financial products by Australian investors. To provide additional clarity to all stakeholders, the circumstances in which the materiality test was likely to be met and the factors that the regulators would take into consideration could be described in revised regulatory guidance or another legislative instrument.

The proposed test would be implemented through legislative reform to the Corporations Act. It is proposed that the Corporations Act would set out the test at a high level, with more detailed criteria set out in legislative instruments (e.g. a Ministerial determination or regulations) and/or revised regulatory guidance.

It is not expected that the proposed new approach would result in additional CS facilities falling within the scope of Australia's CS facility licensing regime. Furthermore, the rest of the Australian CS facility licensing regime would remain unchanged by this proposal. The factors relevant to consideration of the materiality of a CS facility's connection to the Australian financial system by the regulators are already listed in ASIC's Regulatory Guide 211 – Clearing and Settlement Facilities: Australian and Overseas Operators (RG 211). The intent of the proposed approach is to formalise how these factors are currently, and in the future will be, weighed in reaching judgements around regulatory scope so as to provide clarity and transparency for prospective future CS facility licence applicants.

The CFR has considered feedback received from consultation on the initial proposal. The remainder of this report summarises the key feedback from stakeholders along with the CFR's views on how this feedback should be addressed in implementing the proposed framework. Any legislative change will ultimately be a matter for the government to consider.

Overview of Consultation Responses and Response to

Feedback

The CFR received five written submissions from stakeholders, including from major overseas CS facilities. This section summarises the stakeholder feedback received and sets out the CFR's responses.

On balance, stakeholders agreed that the proposed approach would provide useful additional clarity on whether a CS facility should be licensed in Australia or exempt from Part 7.3 of the Corporations Act. There was support for the proposed criteria and stakeholders generally acknowledged the need for the test to be flexible. Such flexibility was seen as important to ensure that the regulators could respond appropriately to future changes in the provision of CS services.

Case for reform

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Two stakeholders commented that the current test in section 820A of the Corporations Act (i.e. whether a CS facility was 'operating in this jurisdiction') and the broader Australian CS facility licensing regime were functioning effectively. One of those stakeholders considered that the case for reform was not made in the consultation paper and that higher priority should be assigned to other more important financial sector reforms currently underway.

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As noted in the consultation paper, the regulators have identified, through discussions with a number of overseas CS facilities, that there is a lack of clarity in the existing regime. Accordingly, the CFR considers that there would be substantial benefit to providing greater clarity, as well as increased legal certainty, for all stakeholders on the circumstances in which a CS facility must be either licensed in Australia or exempted from Part 7.3 of the Corporations Act. Indeed, the majority of feedback agreed that the proposed approach provided more clarity relative to the current test. Furthermore, by providing additional clarity, while maintaining flexibility, it is expected that the proposal will continue to promote Australian entities' ongoing access to a diverse range of CS options, both in Australia and overseas.

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The CFR recommends that the changes to the Corporations Act required to implement the proposal set out in the consultation paper be made in conjunction with proposed legislative reforms required to implement a special resolution regime for CS facilities and trade repositories (together referred to as financial market infrastructures (FMIs)). Linking the proposal to this high-priority package of legislative changes, for which there is considerable industry support, should address any concern that it might divert resources from other more pressing financial sector reforms. There is a natural link between these proposals. In particular, clarity as to the scope of the Australian CS facility licensing regime is foundational to defining the scope of application of the special resolution regime for FMIs. The core elements of the FMI resolution regime would apply to CS facilities that held a domestic CS facility licence, but a subset of proposed powers would apply to any overseas CS facility within the scope of the Australian CS facility licensing regime. These reforms are expected to occur as part of a broader package of financial sector reforms implemented in response to the Financial System Inquiry.

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There were no objections to the proposal that a CS facility with a domestic connection should notify the regulators. However, some stakeholders queried how this requirement would be enforced and noted that appropriate incentives would be required to encourage overseas CS facilities to assess themselves against the test and notify the regulators accordingly.

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The CFR would generally expect most overseas CS facilities to have a sufficiently strong incentive to notify the regulators of any domestic connection. Such a notification would trigger a determination from the regulators as to whether the domestic connection was material. A determination on materiality would in turn provide certainty for the CS facility and its participants as to whether the CS facility needed to be licensed to conduct any activities that had a connection with Australia. The CFR would also generally expect that some Australian participants would encourage any overseas CS facility that they used to seek the necessary determination, in order to avoid the potential for implementation of higher capital requirements if there were uncertainties about the regulatory regime that applied to the CCP. Accordingly, the CFR considers there should already be sufficient incentives in place to encourage correct self-assessment and notification to the regulators.

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Nevertheless, the CFR proposes that in consulting on the draft legislative amendments to the Corporations Act to implement the proposed framework, further consideration could usefully be given to additional mechanisms to promote compliance with the notification requirement. This could include the regulators being granted a specific and limited power to make enquiries of an overseas CS facility to ascertain whether the CS facility had a domestic connection. It is expected that any such power would only be exercised in limited circumstances; for instance, where the regulators had reason to believe that a CS facility had a domestic connection but had not provided the required notification.

Materiality of a CS facility's domestic connection

The majority of stakeholder feedback related to the second component of the test, which addresses the materiality of a CS facility's domestic connection.

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Further guidance and quantitative thresholds: Some stakeholders sought further guidance on various aspects of the materiality component of the test. In particular, they favoured quantitative criteria and thresholds to provide additional certainty.

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The CFR acknowledges the desire for more certainty. However, close consideration was given to this matter in developing the proposal and the CFR concluded that to adopt quantitative thresholds would unduly restrict the regulators in weighing the various factors relevant to determining the materiality of a CS facility's domestic connection. This could result in the regime capturing some CS facilities that were not relevant to the safe, efficient and effective functioning of the Australian financial system or the confident, fair and effective dealings in financial products by Australian investors, and excluding some CS facilities that were relevant. Including quantitative criteria and thresholds in the proposal would also add rigidity by limiting the scope of the regulators to respond to future changes in the provision of CS services. Ensuring sufficient flexibility was a particular consideration for the CFR in developing the approach. Indeed, the need to avoid undue rigidity was seen by two stakeholders as crucial to ensuring that the licensing regime was not a barrier to Australian entities accessing overseas CS facilities to support their financial market activities.

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Through the proposed framework, the CFR has sought to strike an appropriate balance between the need for legal certainty and the need both to allow the regulators flexibility to exercise judgement in weighing relevant factors, and to respond to future changes in the structure and operation of financial markets and CS facilities. Accordingly, the regulators favour engaging bilaterally with overseas CS facilities and providing additional guidance on a case-by-case basis.

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Australian users: Informal bilateral feedback was provided querying whether the term 'user' could be defined more restrictively to apply to an ascertainable population of indirect users of CS facilities.

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One of the purposes of regulating CS facilities is to protect investors dealing in financial products and other users of CS facilities. The CFR therefore considers it appropriate that the reference to 'Australian users' be retained in the materiality component without defining the term more restrictively. The CFR recognises there may be some practical impediments to a CS facility's ability to identify Australian users, particularly where a CS facility has no direct contractual relationship with its indirect users – and especially where there are several tiers of indirect users. The regulators would expect to engage with any overseas CS facility that had a domestic connection to understand what information on indirect users was available and how the determination could best be made without imposing an undue regulatory burden.

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Affiliated operators: One stakeholder recommended that where different entities in an affiliated group operate CS facilities (i.e. CS services) for different classes of products, the materiality of those different CS facilities be assessed separately.

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In assessing the materiality of a CS facility's connection, the regulators would expect to assess each CS facility separately, recognising that a legal entity may operate multiple CS facilities, or that multiple CS facilities may be operated by different legal entities that are part of the same affiliated group (particularly for different product types). Part 7.3 of the Corporations Act recognises that one entity could operate more than one CS facility. The regulators would consider, on a case-by-case basis, what constituted an individual CS facility as this would depend on a number of factors, including the corporate, organisational, operational and financial structure of the CS facility operator's activities. In addition, the regulators would assess each legal entity that operates a CS facility individually, and would not assess affiliated legal entities together.

Transitional arrangements

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Stakeholders sought additional clarity on transitional arrangements, where a CS facility's domestic connection that was not previously determined to be material became material over time (e.g. where the number of Australian participants or volume grew over time).

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The CFR proposes that in consulting on the draft legislative amendments to implement the proposed framework, further consultation be undertaken on appropriate transitional arrangements for CS facilities that become more materially connected over time. For a CS facility that was determined not to have a material domestic connection, it is envisaged that some form of regular reporting and/or engagement would continue with the regulators. Through this process, the regulators would be able to guide such a facility through any transitional arrangements should the assessment of its materiality change. It is expected that any transitional arrangements would provide the affected entity with a reasonable period of time to either transition to become licensed, or to reduce the materiality of its Australian activities.

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Two stakeholders expressly agreed with the proposed approach that ASIC, in consultation with the RBA, would make a determination as to whether a CS facility's activities were material. One stakeholder, however, favoured a single regulatory point of communication, while another suggested that a decision on materiality should be subject to public consultation before a final determination was made.

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Both ASIC and the RBA have regulatory responsibilities under the Corporations Act in relation to CS facilities, and it is therefore appropriate that overseas CS facilities communicate with both regulators. However, the regulators carry out their responsibilities in a cooperative and coordinated manner in order to prevent unnecessary duplication of effort and to minimise the regulatory burden on facilities.

-

The regulators would not generally expect to consult publicly in determining the materiality of a CS facility's domestic connection, since such a decision would be taken in the context of the routine exercise of regulatory responsibility.

Implementation

•

Implementation: One stakeholder agreed that codifying the key elements of the framework in the Corporations Act and associated regulations would provide more certainty for stakeholders; although two stakeholders noted that the proposed approach could introduce unnecessary rigidity. It was also suggested that in making the legislative changes, the regulators should consult on timing and content with overseas regulators to mitigate cross-border regulatory conflict.

-

Consistent with the consultation paper, the CFR considers that the overarching, high-level test could be incorporated into the Corporations Act, with the associated circumstances and factors for consideration implemented through a legislative instrument (e.g. a Ministerial determination or regulations) and/or revised regulatory guidance. Including the more detailed factors for consideration in revised regulatory guidance would ensure that the proposed framework retained the flexibility necessary for the regulators to consider each CS facility's circumstances on a case-by-case basis, while providing clarity for stakeholders about how the regulators expected to apply the framework. Further public consultation would take place on the text of draft legislation, regulation and guidance, and any comments from overseas entities and regulators would be considered.

Other stakeholder feedback

Some stakeholders also raised issues that were less widely commented on among respondents.

•

A CS facility's domestic connection – branches of Australian institutions: One stakeholder suggested that in considering whether a CS facility provided CS services to an Australian participant, the regulators should differentiate between overseas branches of Australian financial institutions that were also supervised by an overseas authority, and the Australian financial institutions located in Australia.

-

Where a CS facility provides CS services directly to an overseas branch of an Australian institution, that branch would be considered to be an Australian participant since it is not a separate legal entity. While the provision of services to an Australian participant would constitute a domestic connection requiring notification to the regulators, it would not automatically mean that the CS facility was required to be licensed in Australia or exempt from licensing under Part 7.3 of the Corporations Act; the regulators would still need to form a judgement as to whether the CS facility's domestic connection was material.

•

Arrangements with other financial markets or CS facilities: One respondent suggested avoiding a direct link between licensing requirements for CS facilities and market operators that belonged to the same group.

-

Under the proposed approach, a CS facility that had an arrangement with a financial market or CS facility operator that was licensed or exempt under the Australian regime would be considered to have a domestic connection. Furthermore, an arrangement with a holder of a domestic Australian market licence or an Australian CS facility licence (i.e. granted under section 795B(1) or section 824B(1) of the Corporations Act, respectively) would constitute a material domestic connection.

-

However, an arrangement with the holder of an overseas Australian market licence or an overseas Australian CS facility licence (i.e. granted under section 795B(2) or section 824B(2) of the Corporations Act, respectively), would not in and of itself constitute a material domestic connection.

Other matters

Individual stakeholders also raised other matters that were not within the scope of the consultation paper.

•

Mutual recognition with overseas jurisdictions: It was suggested that the CFR consider mutual recognition of regulatory oversight between the Australian and overseas regulatory authorities.

-

The Australian regulatory regime already provides for recognition of oversight by an overseas regulatory authority. In particular, Part 7.3 of the Corporation Act provides an alternative licensing route for overseas CS facilities, which is intended to avoid regulatory duplication. This is available where the operation of a CS facility in an overseas country (i.e. a CS facility's 'home jurisdiction') is subject to requirements and supervision that are sufficiently equivalent to those in Australia. An assessment of sufficient equivalence is made when the facility submits an application for an Australian CS facility licence under section 824B(2) of the Corporations Act, rather than at the point at which a determination is made as to whether a facility falls within the scope of the licensing regime.

•

Disclosure for CS facility users about domestic and overseas CS facilities: Another stakeholder suggested that the framework should establish disclosure requirements to ensure that CS facility users understand the differences between dealing with an overseas licensed CS facility and a domestically licensed CS facility.

-

The CFR does not propose to consider such disclosure requirements as part of the legislative proposal at hand. Such disclosure requirements are only relevant once a CS facility is licensed. The Australian regulatory regime for CS facilities already requires certain disclosures which help to ensure that participants and other users are appropriately informed in their dealings with licensed CS facilities, whether domestic or overseas, including under the RBA's Financial Stability Standards. The regulators would consider if any additional disclosure was required on a case-by-case basis, and have, in some cases, imposed licence conditions requiring such disclosure.

Next Steps

The CFR is advising the government on the development of draft legislation that reflects the proposals set out in the CFR's March 2015 consultation paper and this response to consultation. The draft legislation will incorporate changes to the Corporations Act to implement a special resolution regime for FMIs, since the resolution regime for CS facilities would build on the licensing regime. ²

Stakeholders will be given the opportunity to comment on draft legislation to implement the proposed changed approach to assessing whether an overseas CS facility must be either licensed in Australia or exempted from Part 7.3 of the Corporations Act in due course.

As similar issues also exist for financial markets, ASIC and Treasury are also considering the application of this proposed new approach to financial markets regulated under Part 7.2 of the Corporations Act.

¹ These proposals are described in the paper 'Resolution Regime for Financial Market Infrastructures: Response to Consultation', available at
http://www.cfr.gov.au/publications/cfr-publications/2015/resolution-regime-financial- market/ .

Resolution Regime for Financial Market Infrastructures, 2015 Consultation Paper, Australian Government

INTRODUCTION AND EXECUTIVE SUMMARY

The Australian Government — acting on the advice of the Reserve Bank of Australia (RBA), the Australian Securities and Investments Commission (ASIC), the Australian Prudential Regulation Authority (APRA) (jointly, the Regulators) and the Australian Treasury — seeks stakeholder views on legislative proposals to establish a special resolution regime for clearing and settlement (CS) facilities and trade repositories (TRs), together referred to as financial market infrastructures (FMIs), consistent with international standards. Some of the legislative proposals in this paper relating to directions powers and international regulatory cooperation also extend to operators of domestically incorporated and licensed financial markets.

Considerable work has been done in recent years, both domestically and internationally, to develop best practice standards for bank resolution regimes. Attention has now turned to the establishment of similar regimes for FMIs.

Although robust risk management significantly reduces the likelihood of an FMI failure, the possibility of such failure is not entirely eliminated. With increasing dependence on centralised infrastructure, motivated in part by regulatory reforms, it is vital that the official sector clarifies how it would address a situation of FMI distress. The particular focus of this consultation paper is on resolution: actions taken by public authorities to either return an FMI to viability or facilitate its orderly wind-down. The associated concept of recovery refers to actions taken by a distressed FMI itself to return to viability.

The set of proposals described in this paper aims to ensure, as appropriate, the timely and effective resolution of a failing FMI in a manner that maintains financial system stability while avoiding the use of public funds to the maximum extent possible.

1.1 BACKGROUND

For the purposes of this paper, FMIs are defined as multilateral systems used to clear, settle and record financial transactions.

1. Clearing is a post-trade and pre-settlement function performed by financial market participants to manage trades and associated exposures. Through the legal process of novation, a central counterparty (CCP) interposes itself between counterparties to transactions executed in the markets it serves, becoming principal to each transaction so as to ensure performance of obligations.

2. Settlement is the point at which the counterparty exposures associated with a transaction are eliminated. In securities markets, settlement is facilitated by securities settlement facilities (SSFs).

3. TRs are facilities that centrally collect and maintain records on over-the-counter (OTC) derivatives transactions and positions for the purpose of making those records available to regulators and, to an appropriate extent, the public.

Internationally, the Financial Stability Board (FSB), the Committee on Payments and Market Infrastructures (CPMI, formerly the Committee on Payment and Settlement Systems (CPSS)) and the International Organization of Securities Commissions (IOSCO) have progressed work on international guidance for FMI recovery and resolution. The FSB adopted the

Key Attributes of Effective Resolution Regimes for Financial Institutions (the KAs) in October 2011, and the G20 Leaders endorsed these KAs in November 2011. ¹ The FSB subsequently added guidance for applying the KAs to FMIs (the FMI Annex to the KAs) in October 2014. Together, the KAs and the FMI Annex to the KAs identify the powers and limits of a resolution framework for financial institutions, including FMIs. CPMI and IOSCO also published guidance on the development of recovery plans for FMIs in October 2014. ² The guidance provided in these documents extends to CS facilities and TRs, but not financial markets.

The FSB is monitoring jurisdictions' progress in implementing the KAs, including in respect of FMIs, through a series of peer reviews. The first such review was published in April 2013 and noted that resolution regimes for FMIs were generally less developed than corresponding regimes for banks. Australia was one of sixteen jurisdictions identified in the report as having no administrative authority responsible for resolution of FMIs.

This gap had already been identified by the Council of Financial Regulators ³ (the CFR) in its 2011 review of FMI regulation, which resulted in a recommendation to Government in February 2012 to develop a special resolution framework for CS facilities and financial markets. The CFR's review and recommendations did not apply to TRs, as TRs were not at that time subject to licensing and regulation under Chapter 7 of the Corporations Act 2001 (the Corporations Act). ⁴ In particular, the CFR noted that 'the absence of a specialised resolution regime' for CS facilities and financial markets represented a gap in the current regulatory framework. The CFR's key recommendations were to:

4. strengthen the ability of regulators to deal with distress situations at key CS facilities and financial markets by streamlining and clarifying the directions powers provided in the legislation;

5. enhance the ability of regulators to maintain financial stability in times of stress by establishing a statutory management (step-in) regime allowing ASIC and the RBA to take control of a domestically licensed CS facility or financial market in certain defined circumstances.

In principle, if a comprehensive recovery plan could be executed effectively, resolution would not be necessary. However, in some circumstances, an FMI may be unable to fully implement its recovery plan without direct public intervention. In others such intervention may be desirable in the interests of financial system stability, even if recovery actions could be taken. The availability of a special resolution regime as an alternative to general insolvency would allow actions to be taken by a resolution authority with a system-wide perspective. In particular, the resolution authority would seek to restore critical services to viability, while allowing non-critical services to be wound down in an orderly manner. Ancillary powers would be provided for the resolution authority to pursue alternative means of maintaining service continuity, such as a transfer of operations to another entity.

^1. FSB, Key Attributes of Effective Resolution Regimes for Financial Institutions, October 2014, available at:
www.financialstabilityboard.org/2014/10/r_141015/

^2. CPMI-IOSCO, Recovery of financial market infrastructures, October 2014, available at:
www.bis.org/cpmi/publ/d121.htm

^3. The Australian Treasury, the Reserve Bank of Australia, the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority.

^4. See the CFR's recommendations to government on recommendations from its review of FMI regulation. The CFR's letter to the then Deputy Prime Minister and Treasurer is available at:
www.treasury.gov.au/ConsultationsandReviews/Consultations/2012/CFR-Financial-Market-Infrastructure- Regulation

A legislative framework that clearly identified the tools and powers available to a relevant resolution authority would provide valuable certainty to market participants. This would be particularly important in times of stress.

1.2 LEGISLATIVE PROPOSALS

In developing legislative proposals for an Australian FMI resolution regime, the Government has sought to ensure consistency with the KAs, as well as the recommendations of the 2011-12 CFR review of FMI regulation.

In globalised financial markets, international standards for resolution regimes provide an important common benchmark for all jurisdictions to follow. It is therefore proposed that the domestic regime be consistent with the KAs and the FMI Annex to the KAs, which apply to CS facilities and TRs. Attachment A includes a table that maps the proposed regime against the KAs and the FMI Annex.

The proposals in this paper are also designed, where relevant, with reference to powers available to APRA under the Banking Act 1959 (the Banking Act) and the Financial Sector (Business Transfer and Group Restructure) Act 1999 (the Business Transfer Act) for the resolution of authorised deposit-taking institutions (ADIs).

1.2.1 Institutional scope, objectives and resolution authority

The legislative proposals in this paper extend to:

•

all CS facilities that are incorporated in Australia and hold a domestic CS facility licence;

•

all TRs that are incorporated and licensed in Australia and that are identified as being systemically important in Australia.

Some of the legislative proposals in this paper also extend to financial markets that are incorporated in Australia and hold a domestic market licence.

Consistent with the CFR's published framework for regulatory influence over cross-border CS facilities, additional amendments to the Corporations Act are proposed to require all systemically important cross-border CS facilities that are strongly connected to the Australian financial system and real economy to operate from an entity incorporated in Australia, and hold a domestic CS facility licence. This would bring them within the scope of the resolution powers proposed in this paper.

Once an FMI was in resolution, certain powers would also extend to any related entity that provided the FMI with critical services or funding support under ex-ante legal arrangements.

It is proposed that the RBA would act as resolution authority for CS facilities, and ASIC as resolution authority for TRs. An overarching objective for the RBA in taking resolution actions in relation to CS facilities would be to maintain overall stability in the financial system. ⁵ Consistent with maintaining system stability, an additional common key objective of both resolution authorities would be to maintain the continuity of CS facility and TR services that are critical to the smooth functioning of the financial system. These objectives would be complemented by a set of considerations for the resolution authorities, covering matters such as maintenance of market confidence and integrity, protection of public funds, and minimisation of the costs of resolution to creditors and shareholders.

^5. ASIC does not have a financial stability mandate in relation to TRs.

1.2.2 Resolution powers

The objectives of the resolution authority may be best pursued by taking actions in accordance with an FMI's own operating rules, including the allocation of uncovered losses. These actions would be supported by a range of powers available to the resolution authority.

The legislative proposals draw a distinction between general conditions (those that establish the case for public intervention) and specific conditions (those that are used to select between particular resolution actions) for the exercise of resolution powers. The powers proposed for the resolution authority in relation to FMIs are:

•

Statutory management. The power to appoint an individual, company or the resolution authority itself to temporarily administer a distressed FMI in a manner consistent with the objectives of the resolution regime. The statutory manager would assume the powers of the FMI's board, including carrying out recovery measures and other actions in accordance with the FMI's rulebook. The exercise of powers by the statutory manager would be overseen by the resolution authority.

•

Moratorium on payments to general creditors. The power to suspend an FMI's payment obligations to general creditors. This would exclude payments made in relation to core FMI activities (such as margin payments and settlement of securities transactions).

•

Transfer of operations to a third-party or bridge institution. The power to compulsorily transfer all or part of an FMI's operations to a willing third-party purchaser, or a temporary bridge institution established by public authorities. A transfer to the latter would be intended as an interim step towards a return to private sector ownership under new governance arrangements.

•

Temporary stay on early termination rights. The power to impose a temporary stay of up to 48 hours on termination rights (with respect to future obligations) that may be triggered solely by an FMI's entry into resolution. It is also expected that FMIs would ensure that such termination rights were not included in their rules or contracts with critical third-party suppliers.

1.2.3 Safeguards and funding arrangements

The powers available to the resolution authority have the potential to significantly impact participants and other stakeholders that have dealings with FMIs. The legislative proposals provide a right to compensation from the Commonwealth should participants or other stakeholders be left worse off in resolution than they would have been had the FMI entered general insolvency. ⁶ The proposals also include an immunity from liability for the resolution authority, statutory manager and others acting in compliance with the directions of the resolution authority.

^6. A modified compensation test could apply where resolution actions were taken to address a deficiency in financial resources that was not large enough to trigger insolvency, or other non-insolvency related threats to service continuity.

It is envisaged that in some resolution scenarios, there could be a need to draw on public funds to provide temporary liquidity, to ensure the timely disbursement of operating expenses, or in some extreme cases to meet a small shortfall required to complete an FMI's closeout processes. In each of these cases the Government would seek to recover any expenditure from participants and shareholders of the FMI.

1.2.4 International cooperation and supporting requirements

The institutional scope of the proposed resolution regime does not extend to overseas-based FMIs. However, the proposals recognise that Australian authorities should also have the capacity to take limited action in support of resolution actions by overseas authorities in respect of overseas-based FMIs and financial markets that are licensed to operate in Australia. It is not currently expected that legislative change would be required to enable the relevant authorities to engage in information-sharing with foreign authorities or to participate fully in multilateral cooperative crisis management arrangements for such FMIs and financial markets. The proposal nevertheless considers measures to give a legislative basis for the cooperation of a foreign authority responsible for oversight of any overseas-based FMI or financial market that holds an Australian licence.

The proposals also address several matters required to support the practical implementation of the resolution regime, although these are not expected to require specific legislation. These include the development and maintenance of recovery and resolution plans, and assessments of the feasibility of resolution plans for each FMI.

1.2.5 Directions powers

While not a particular focus of the KAs, the legislative proposals set out a range of enhancements to the powers of regulators and resolution authorities to give directions to FMIs and financial markets. These powers, primarily designed to support the successful implementation of recovery and resolution actions, also develop some more general recommendations made by the CFR following the 2011-12 consultation. They would introduce a streamlined process for the timely issuance of directions, and also strengthened sanctions for a failure to comply, including criminal sanctions.

Among the recommendations, it is proposed that the RBA be granted the power to issue directions to CS facilities on its own behalf in respect of matters relevant to its financial stability responsibilities. In addition, it is proposed that ASIC and the RBA would each be granted the power to issue directions to support an FMI's recovery actions and its own resolution actions. These powers would extend to ASIC's regulatory role in respect of financial markets. Resolution-related directions powers would extend to related entities of an FMI that provided critical services or funding to the FMI under ex-ante legal agreements (for example, the holding company of an FMI, or an operational affiliate).

1.3 OUTLINE OF CONSULTATION PAPER

The remainder of the paper is structured as follows. Section 2 discusses the intended institutional scope of the special resolution regime, as well as the statutory objectives and the proposed resolution authority for each of CS facilities and TRs. Section 3 discusses the relationship between an FMI's own recovery measures and resolution, going on to consider the triggers for entry into resolution and the range of powers and tools that would be made available to the resolution authority. Sections 4 and 5 respectively cover safeguards and funding arrangements, and international cooperation. Section 6 closes with proposals for enhancements to the directions powers available to ASIC and the RBA, both to support recovery and resolution actions and day-to-day oversight activities.

Resolution Regime for Financial Market Infrastructures, 2015 Response to Consultation, Council of Financial Regulators

Introduction and Background

In February 2015, the Australian Government, acting on the advice of the Council of Financial Regulators (CFR) — made up of the Reserve Bank of Australia (RBA), the Australian Securities and Investments Commission (ASIC), the Australian Prudential Regulation Authority (APRA) and the Australian Treasury — released a consultation paper seeking stakeholder views on legislative proposals to establish a special resolution regime for clearing and settlement (CS) facilities and trade repositories, together referred to as financial market infrastructures (FMIs). ¹ Some of the legislative proposals in the paper also extend to domestically incorporated holders of a domestic market licence. ²

The key features of the legislative proposals set out in the government's consultation paper are summarised below. The proposals are aligned with the Financial Stability Board's (FSB's) Key Attributes of Effective Resolution Regimes for Financial Institutions (the Key Attributes), including an Annex that addresses how the general principles set out in the Key Attributes can be adapted in designing resolution regimes for FMIs (FMI Annex). ³

•

Institutional scope, objectives and resolution authority. The FMI resolution regime would extend to operators of CS facilities that are incorporated in Australia and hold a domestic CS facility licence,4 as well as trade repositories that are incorporated and licensed in Australia. The RBA would act as resolution authority for CS facilities, and ASIC as resolution authority for trade repositories. An overarching objective for the RBA in taking resolution actions in relation to CS facilities would be to maintain overall stability in the financial system, with an additional common key objective for both resolution authorities to maintain the continuity of CS facility and trade repository services that are critical to the smooth functioning of the financial system. These objectives would be complemented by a set of considerations for the resolution authorities in choosing between resolution actions, covering matters such as maintenance of market confidence and integrity, protection of public funds, and minimisation of the costs of resolution to creditors and shareholders.

-

A complementary proposal would require all systemically important CS facilities that are strongly connected to the Australian financial system or real economy to be operated by an entity that is incorporated in Australia and holds a domestic CS facility licence.

•

Resolution powers. The objectives of the resolution authority may be best pursued by taking actions in accordance with an FMI's own operating rules, including the allocation of uncovered losses. These actions would be supported by a range of powers available to the resolution authority. The powers proposed for the resolution authority in relation to FMIs are:

-

Statutory management. The power to appoint an individual, company or the resolution authority itself to temporarily administer a distressed FMI in a manner consistent with the objectives of the resolution regime. The statutory manager would assume the powers of the FMI's board, including carrying out recovery measures and other actions in accordance with the FMI's rulebook. The exercise of powers by the statutory manager would be overseen by the resolution authority.

-

Moratorium on payments to general creditors. The power to suspend an FMI's payment obligations to general creditors. This would exclude payments made in relation to core FMI activities (such as margin payments and settlement of securities transactions).

-

Transfer of operations to a third party or bridge institution. The power to compulsorily transfer all or part of an FMI's operations to a willing third-party purchaser, or a temporary bridge institution established by public authorities. A transfer to the latter would be intended as an interim step towards a return to private sector ownership under new governance arrangements.

-

Temporary stay on early termination rights. The power to impose a temporary stay of up to 48 hours on termination rights (with respect to future obligations) that may be triggered solely by an FMI's entry into resolution. It is also expected that FMIs would ensure that such termination rights were not included in their rules or contracts with critical third-party suppliers.

•

Safeguards and funding arrangements. The legislative proposals provide a right to compensation from the Commonwealth should participants or other stakeholders be left worse off in resolution than they would have been had the FMI entered general insolvency. The proposals also include an immunity from liability for the resolution authority, statutory manager and others acting in compliance with the directions of the resolution authority. It is envisaged that in some resolution scenarios, there could be a need to draw on public funds. In such cases, the government would seek to recover any expenditure from participants and shareholders of the FMI.

•

International cooperation and supporting requirements. The proposals recognise that Australian authorities should also have the capacity to take limited action in support of resolution actions by overseas authorities in respect of overseas-based FMIs and financial markets that are licensed to operate in Australia. The proposals also address several matters required to support the practical implementation of the resolution regime, although they are not expected to require specific legislation. These matters include the development and maintenance of recovery and resolution plans, and assessments of the feasibility of resolution plans for each FMI.

•

Directions powers. The legislative proposals set out a range of enhancements to the powers of regulators and resolution authorities to give directions to FMIs and financial markets. These powers, primarily designed to support the successful implementation of recovery and resolution actions, also develop some more general recommendations made by the CFR in 2012. ⁵ They would introduce a streamlined process for the timely issuance of directions, and also strengthen sanctions for a failure to comply, including criminal sanctions. Among the recommendations, it is proposed that the RBA be granted the power to issue directions to CS facilities on its own behalf in respect of matters relevant to its financial stability responsibilities. In addition, it is proposed that ASIC and the RBA would each be granted the power to issue directions to support an FMI's recovery actions and its own resolution actions. These powers would extend to ASIC's regulatory role in respect of financial markets (as recommended by the CFR in 2012). Resolution-related directions powers would extend to related entities of an FMI that provided critical services or funding to the FMI under ex ante legal agreements.

⁵ See CFR (2012), 'Review of Financial Market Infrastructure Regulation: Letter to the Deputy Prime Minister and Treasurer', February. Available at
http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2012/~/media/Treasury/Consultations%20and%20Reviews/Consultations/2012/CFRWG%20on%20Financial%20Market% 20Infrastructure%20Regulation/Key%20Documents/CoFR_Letter_to_Deputy_PM.ashx .

Internationally, while a number of jurisdictions have taken steps towards implementation of FMI resolution regimes (including the United Kingdom and Hong Kong), most jurisdictions are still in the early stages of implementing guidance set out in the FMI Annex to the Key Attributes. The progress of international authorities in implementing FMI resolution, and any gaps in existing practices or guidance, will be examined as part of a broader work plan focused on central counterparties (CCPs) led by the FSB in cooperation with the Committee on Payments and Market Infrastructures, International Organization of Securities Commissions and Basel Committee on Banking Supervision. This work is intended to promote CCP resilience, recovery planning and resolvability, with the FSB leading work on CCP resolution.

The CFR has considered feedback received from consultation on the initial proposals on FMI resolution summarised above, as well as continuing developments internationally. The remainder of this report summarises the key feedback from stakeholders and sets out the CFR's views on how this feedback should be addressed in developing draft legislation to establish an Australian FMI resolution regime. Stakeholders are invited to comment on these view

Review of Financial Market Infrastructure Regulation, 2011 Consultation Paper, Council of Financial Regulators

Executive summary

At the request of the Deputy Prime Minister and Treasurer, the Hon. Wayne Swan MP, the Council of Financial Regulators (the Council) is conducting a review of the regulatory framework for financial market infrastructure (FMI) in Australia (the Review).

The need to undertake the Review was highlighted in the course of the regulatory agencies' consideration of the proposed takeover of ASX Limited (ASX) by Singapore Exchange Limited (SGX).

The regulatory issues considered in this paper are among the reasons why the Deputy Prime Minister and Treasurer concluded that SGX's proposed takeover of ASX was not in the national interest. The Deputy Prime Minister and Treasurer in his decision referred to the Foreign Investment Review Board's (FIRB's) finding, which incorporated advice from the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA), that:

not having full regulatory sovereignty over the ASX-SGX holding company would present material risks and supervisory issues impacting on the effective regulation of the ASX's operations, particularly its clearing and settlement functions. Australia's financial regulators have advised me that reforms to strengthen our regulatory framework should be a condition of any foreign ownership of the ASX to remove these risks. ¹

To address these issues, the Deputy Prime Minister and Treasurer asked the Council to establish a Working Group to consider potential measures that could be introduced to ensure that Australian regulators could continue protecting the interests of Australian issuers, investors and market participants. A key consideration is to preserve the integrity of Australia's financial infrastructure and the ability of supervisors to maintain robust oversight and appropriate control in all market conditions, including in the advent of a range of different ownership structures for FMIs of systemic importance to the Australian financial system.

More broadly, the increasing interconnectedness of global markets means that the Australian regulatory framework must keep pace with developments offshore. In that regard, if Australian FMIs are to link with an offshore FMI, or offshore-owned FMIs are to operate in domestic markets, there is a need to maintain robust oversight and appropriate control of such infrastructures. These regulatory concerns extend to crisis resolution arrangements.

While some relevant international regulatory concerns pre-date the global financial crisis, the crisis has given impetus to ensuring that the interconnections between systemically important financial institutions and FMIs do not give rise to significant systemic risks (or that those risks are robustly mitigated). The Wall Street Reform and Consumer Protection Act (US) 2010 (Dodd-Frank), the proposed European Market Infrastructure Regulation (EMIR) ² and the United Kingdom (UK) Treasury's White Paper on Financial Markets, ³ all address these issues.

One approach has been to seek to centrally manage risks formerly addressed bilaterally (for example in over-the-counter (OTC) derivatives markets). The Group of Twenty countries (G20) have committed to require that all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCPs) by the end of 2012.

At the same time as this regulatory scrutiny has been unfolding, there has been an acceleration of consolidation activity across FMIs. Some FMIs and trading venues are seeking alliances to enhance their competitiveness. Other trading venues and FMIs have been seeking consolidation at the exchange or clearing level. It is not yet clear how these strategies, or regulators' reactions to them, will play out.

Accordingly, quite apart from the circumstances surrounding ASX, which have prompted renewed focus of Australian Government and agencies on these issues, a review of Australia's regulatory framework for FMIs is timely to ensure Australia's regulatory framework is at least as robust as those of other international financial centres.

Improving the regulatory framework for FMIs in Australia will not only underwrite the continued integrity of Australia's market infrastructure and so contribute to the efficiency and stability of Australia's financial system, but will also ensure that Australia remains open to foreign investment and foreign financial service providers.

Part A of this paper:

•

describes the Treasurer's terms of reference and the regulatory framework including the existing responsibilities and powers of regulators (see chapter 2);

•

describes Australia's FMIs of systemic importance (see chapter 3); and

•

describes certain weaknesses in the regulatory framework, particularly in comparison with regulatory powers in respect of authorised deposit-taking institutions (ADIs) (see chapter 4).

Part B of this paper sets out the Council's proposed regulatory responses to the issues identified. Part C of this paper explains the next steps and sets out the questions for stakeholder feedback.

¹ Deputy Prime Minister and Treasurer, Media Release No. 030 of 8 April 2011, available at
http://www.dpm.gov.au/DisplayDocs.aspx?doc=pressreleases/2011/030.htm .

² On 15 September 2010, the European Commission published its final proposal for a Regulation of the European Parliament and of the Council (also widely known as European Market Infrastructure Regulation – EMIR), which sets out to increase stability within OTC derivative markets. The EMIR introduces: a reporting obligation for OTC derivatives; a clearing obligation for eligible OTC derivatives; measures to reduce counterparty credit risk and operational risk for bilaterally cleared OTC derivatives; common rules for central counterparties (CCPs) and for trade repositories; and rules on the establishment of interoperability between CCPs. At the time of writing the most recent draft compromise text published by the European Council was available at
http://register.consilium.europa.eu/pdf/en/11/st13/st13595.en11.pdf .

³ HM Treasury, A new approach to financial regulation: the blueprint for reform (Cm 8083 June 2011).

Review of Financial Market Infrastructure Regulation, Advice to Government, Council of Financial Regulators

10 February 2012

The Hon. Wayne Swan, MP

Deputy Prime Minister and Treasurer Parliament House

CANBERRA ACT 2600

Dear Deputy Prime Minister,

REVIEW OF FINANCIAL MARKET INFRASTRUCTURE REGULATION

I refer to your letter of 8 April 2011 asking the Council of Financial Regulators (Council) to consider possible measures to ensure that the regulatory regime for financial market infrastructures (FMls) continues to protect the interests of Australian issuers, investors and market participants.

In response to your letter, a Working Group was established by the Council, chaired by the Treasury, and comprising representatives of the Council agencies. During 2011, the Working Group developed a number of proposals to maintain the integrity, stability and efficiency of Australia's FMis and the ability of FMI supervisors to maintain robust oversight and appropriate control in all market conditions and under a range of different ownership structures.

The Working Group consulted on its proposals in late 2011, publishing a consultation paper, Council of Financial Regulators: Review of Financial Market Infrastructure Regulation, and holding roundtable meetings with interested stakeholders. Four confidential responses and eighteen public responses were received; the public responses were published in early December. A list of respondents is attached.

Most stakeholders acknowledged that the paper identified valid regulatory considerations, though some expressed concerns about the implementation of the proposals and sought clarity on points of detail. The Council therefore recommends legislation broadly in line with the proposals in the consultation paper, but with some refinements and clarifications to ensure that any reforms introduced include appropriate checks and balances.

The following advice sets out the Council's final proposals, based on the analysis carried out by the Working Group during 2011, and stakeholder feedback received during consultation. In formulating the proposals, the Council has had regard to relevant international developments.

Proposals for reform

The Council considers that, while FMis have different characteristics to Authorised Deposit-taking Institutions (ADis), both types of entity can be of systemic importance. It is therefore vital that the FMI regulators, ASIC and the Reserve Bank, have appropriate powers to ensure that FMis manage risks effectively and that any financial distress or operational disruption to an FMI can be dealt with in a manner consistent with continued financial stability. As will be outlined below, the Council considers that statutory powers for the regulation of ADis under the Banking Act provide a useful model for a number of reforms to strengthen the regulatory framework for FMis.

The Council has also identified areas of further reform, including the extension of ASIC's and the Reserve Bank's powers to ensure that a related entity takes reasonable steps to comply with a direction or licence condition where it provides critical services to an FMI. It is recommended that these reforms also be considered in due course, perhaps alongside any relevant future amendments to the Banking Act, or in conjunction with other proposals that may arise from ongoing international dialogue on FMI resolution.

The Council's proposals cover a broad scope of issues and seek to ensure that ASIC and the Reserve Bank can continue to preserve the integrity, stability and efficiency of Australia's financial infrastructure and maintain robust oversight. The proposed measures are designed to be effective in all market conditions, including in the event of any future commercial arrangement between the ASX and another overseas exchange group, or where an overseas facility offers critical FMI services in Australia.

The Council recommends that the following reforms be pursued, with a view to having the framework in place as soon as reasonably practical. The Council is also considering releasing a short paper in the coming months summarising the purpose of the reforms and articulating Council agencies' views on concerns raised by stakeholders during the consultation process.

Regulatory powers of direction and intervention over FMis

The Council considered the effectiveness of regulatory powers of direction and intervention under various operational and financial stress scenarios. The Council also considered interactions with Australia's G-20 commitments in relation to infrastructure supporting over-the-counter (OTC) derivatives markets.

Location requirements

One direct way to increase the scope and effectiveness of regulatory oversight would be to streamline and clarify ASIC's and the Reserve Bank's powers to impose location requirements on licensed FMis.

In particular, the Council recommends that existing powers to impose licence conditions be clarified by giving ASIC and the Reserve Bank an explicit power to impose location requirements in key areas, such as financial and risk management and operational arrangements. In the case of an overseas-based FMI, the scope of such a power should also extend, where appropriate, to the establishment of oversight arrangements that give Australian regulators sufficient influence. In some circumstances, Australian regulators may also insist on a legal presence in Australia, or seek assurance as to the compatibility of the FMI's rules with Australian law. Importantly such requirements should be imposed in a proportional and graduated fashion, striking an appropriate balance between efficiency costs and stability benefits.

It is recommended that the basic power be afforded to ASIC and the Reserve Bank by way of enabling legislation through amendments to the Corporations Act. This should set out the objectives of this power and related criteria, while also providing agencies with flexibility to tailor requirements in a graduated way on a case-by-case basis. The scope of requirements could then be established in accompanying regulations.

It would be important to clarify in regulations and guidance the potential scenarios in which location requirements would typically be imposed, and set out the matters that regulators would take into account. These might include, for example, the systemic importance of the underlying market and the composition of the FMI's participants. Clear guidance along these lines would help address stakeholder concerns around arbitrary application of location requirements and their potential to act as a barrier to entry. Any such requirements should also be subject to consultation with affected parties.

Location requirements are an essential element in equipping ASIC and the Reserve Bank to effectively resolve FMI distress. They would also address a number of fundamental concerns identified by the agencies in the context of the SGX-ASX merger proposal. These include the potentially diminished capacity of domestic regulators to influence the operations of a systemically important FMI that is located offshore, particularly if that FMI serves markets in multiple jurisdictions.

This proposal would also support the Government's implementation of its G-20 commitments by providing a framework to establish whether location requirements are appropriate where central clearing or the use of trading platforms is mandated for OTC derivatives.

Direction-giving powers and sanctions

Regulators' capacity to influence outcomes would be enhanced by amendments to the direction-giving powers and sanctions provided for in the Corporations Act.

In particular, the Council recommends that the process by which ASIC can give directions to Australian Market Licensees (AMLs) and Clearing and Settlement Facility Licensees (CSFLs) be streamlined and clarified so as to facilitate more rapid and certain actions either in a financial or operational distress situation or in the event of a significant breach of licence conditions. The Council also recommends that the Reserve Bank be given the power to issue directions to CSFLs in relation to matters affecting financial stability.

To further increase the effectiveness of regulatory actions, the Council recommends broadening the range of sanctions available where licensees fail to comply with directions and licence conditions. In particular, these should be extended to include criminal sanctions, fines, and civil and administrative penalties. Furthermore, the scope of sanctions should be extended to individual directors and officers of the licensee.

Stakeholders expressed some concern that directors' rights might be infringed and that the possibility of more severe sanctions might discourage some suitable candidates from becoming directors of FMis. In response to these concerns, the Council recommends that enabling legislation, regulation and guidance articulate clearly the scope of the sanctions, delineate the circumstances in which they would be deployed, and clarify that the obligation to comply with directions and licence conditions overrides other duties owed by directors. This is consistent with international principles proposed by the Financial Stability Board, among other international bodies.

A 'fit and proper' standard for directors and officers

Relatedly, the Council considers that it would be beneficial for the efficiency, stability and integrity of the market to strengthen ASIC's power to ensure that key persons involved directly or indirectly in the management of the affairs of FMis meet a 'fit and proper' standard. A similar standard is applied by the Australian Prudential Regulation Authority (APRA) in relation to ADis.

Currently, under the Corporations Act, ASIC is obliged to demonstrate that because of the unfitness of the person involved, there is a risk that the relevant licensee or applicant would breach its obligations under Chapter 7 of the Act. This additional requirement could limit the effectiveness of ASIC's supervision of directors of licensees and its consideration of applicants. The Council considers that a fit and proper standard, without the additional requirement, would therefore be more appropriate.

Step-in powers

To further enhance ASIC's and the Reserve Bank's scope to maintain financial stability, particularly in times of stress, the Council recommends that 'step-in' powers be introduced. In particular, the Council recommends that ASIC and the Reserve Bank be given the power to appoint a statutory manager, where appropriate and in consultation with the Minister, to any domestically licensed FMI (i.e. an FMI operating in Australia as its principal place of business) in certain defined circumstances. These should include circumstances such as a threat of insolvency, significant operational outage or distress, or a significant and persistent failure to comply with licence obligations or directions. Similar powers are again available to APRA in respect of ADis and the absence of a specialised resolution regime for FMis represents a gap in the current regulatory framework. Location requirements could support effective step-in in such situations.

To address concerns raised by stakeholders in consultation, the enabling legislation, regulations and published guidance should give clarity around the potential application of these powers. In particular, it should be noted that the Council envisages that ASIC and the Reserve Bank would exercise these powers only where deemed necessary to maintain the continuity of critical services and mitigate systemic risk. The Council considers that it will also be important to provide clarity as to how regulators will ensure that a manager with appropriate experience is appointed.

Systemic importance

A key consideration in regulators' decisions around the exercise of their powers is the systemic importance of an FMI.

The Council recommends that ASIC and the Reserve Bank be given responsibility for determining the systemic importance of market operators and clearing and settlement facilities, respectively, applying an approach and criteria aligned with those developed by the Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions (CPSS-IOSCO) in their Principles for FMis (which are currently in the process of being finalised). This approach would ensure that the basis for assessment in Australia is consistent with other jurisdictions.

Other reforms

In addition to these enhancements to powers of direction and intervention, the Council also consulted on a number of other potential reforms, spanning powers over market operators' listing rules, compensation fund arrangements for securities markets, and client account protections.

Of the additional reforms considered, the Council recommends that legislative changes be pursued in relation to listing rules and compensation fund arrangements. Further policy analysis will be undertaken on client account protections before proceeding with firm recommendations.

In the course of the review of FMI regulation, the question of competition in clearing and settlement also arose. In 2011, the Working Group engaged with the ACCC to further develop analysis on the competition aspects of clearing and settlement. This work is continuing.

Making of listing rules

The Council considered whether there is a case to reform oversight or governance of the ASX's listing rules-making function and associated consultative machinery and, if so, how that could best be achieved.

Currently, neither the Minister nor ASIC have explicit power to require a market operator to make new listing rules, even if this is deemed necessary to promote market integrity and investor confidence. Council agencies are concerned that the incentives of a systemically important Australian market operator to continue to develop and improve its listing rules could diminish in the event that it was acquired by a foreign entity. The agencies are also concerned about investor perceptions that such an acquisition would result in Australian listing standards coming under the influence and ultimate control of a foreign entity, which may be regarded as having weaker standards than the Australian market operator.

Under current arrangements, ASIC may work with market operators in Australia from time to time to make improvements to their listing rules. However, if a proposed improvement were inconsistent with the listing standards adopted by a foreign acquirer in another jurisdiction, informal dialogue between ASIC and that market operator may not be so effective.

The Council therefore recommends that ASIC be given a power to direct market operators to make listing rules with specified content. To address stakeholders' concerns about ASIC involvement in the monitoring of listing rules, enabling legislation, regulations and guidance should clarify that the directions power would be exercised only in exceptional circumstances. It would also be subject to comprehensive checks and balances; in particular, a consultation requirement and Ministerial disallowance. Primary responsibility for monitoring and enforcing listing rules would remain with market operators.

Compensation funds

The Council also considered ways to ensure that the governance around securities exchange compensation arrangements continues to be fit for purpose. The Council considers that reform to governance is desirable to strengthen perceptions of independence in such anangements.

The National Guarantee Fund (NGF) is the fidelity fund for the ASX established under the Corporations Act. It provides investor protection in relation to transactions on the ASX's equity market. The Council recommends that the governance arrangements for the NGF be reformed to allow for a more broadly representative board of directors, appointed by the Minister. Introducing a more representative and transparent governance regime to the NGF could enhance the perceived independence of the NGF and ASX, increase retail investor confidence in the funds, and ultimately raise investor participation in Australia's licensed markets.

The Council also sees merit in reviewing the scope of eligible claims for the NGF, the treatment of Financial Industry Development Account funds, and the possibility of amalgamating the NGF with other investor compensation mechanisms. The goal would be to establish consistency of coverage across the market and ensure that the best use is made of any surplus funds. The Council will consider the need for further consultation in this regard.

Together, these proposed reforms should help to ensure the robustness, resilience and effectiveness of Australia's financial market infrastructure in a rapidly changing global financial system. Should your office wish to discuss or clarify any as ects of these proposals please direct enquiries to [Redacted]

Yours sincerely,

[Signature]

Encl.

cc. Dr John Laker, Chairman, Australian Prudential Regulation Authority

Mr Greg Medcraft, Chairman, Australian Securities and Investments Commission

Dr Martin Parkinson, Secretary to the Treasury

ATTACHMENT

LIST OF SUBMISSIONS TO CONSULTATION PAPER

Public submissions

1. Australian Bankers' Association (ABA)

2. Australian Council of Super Investors (ACSI)

3. Australian Financial Markets Association (AFMA)

4. ANZ, CBA, Macquarie, NAB and Westpac

5. ASX Limited

6. Benjamin Saunders

7. Chartered Secretaries Australia (CSA)

8. Chi-X Australia

9. Chi-X Global Holdings LLC

10. CHOICE

11. GETCO

12. International Swaps and Derivatives Association (ISDA)

13. LCH.Clearnet

14. NSX

15. Ownership Matters

16. Securities Exchanges Guarantee Corporation

17. Stockbrokers' Association of Australia (SAA)

18. Yieldbroker Confidential submissions

19.[Redacted]

20.[Redacted]

21.[Redacted]

22.[Redacted]