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Corporate Law Economic Reform Program - Proposals for Reform: Paper No. 5

Date

Introduction

In announcing the Corporate Law Economic Reform Program (CLERP), the Treasurer referred to the need for Australia to keep pace with technological innovation and the increasing globalisation of the business environment if it is to remain internationally competitive. While modern commercial practices are characterised by technological innovation, Australian law, in some respects, fails to take account of that innovation and is out of touch with the needs of contemporary business operations.

This paper proposes a number of reforms to Australia’s business laws to facilitate electronic commerce. The proposals have been developed in consultation with the business community; in particular, the Government’s Business Regulation Advisory Group (see Appendix A).

‘Electronic commerce’ is a term increasingly used in media reports, government policy documents and business fora. It is a relatively imprecise term which means different things in different contexts. In this paper, ‘electronic commerce’ refers to business transactions on, or using facilities provided by, electronic networks.

Electronic commerce can replace traditional face-to-face ways of doing business and transactions effected through the exchange of paper-based documents. Instead, business can now be transacted quickly over long distances between parties who may never meet (or, indeed, who may not know the identity of each other).

The increasing internationalisation of markets and economies highlights the need to ensure that policies maximise the competitiveness and efficiency of the domestic economy. Australia’s laws must promote the development of systems and market practices that will reduce legal uncertainty and

transaction costs, and increase trading efficiency. This will, in turn, facilitate the competitiveness of Australia’s markets in the global trading environment.

Economic Implications of Electronic Commerce

An economic approach has been adopted by this paper in analysing the issues raised by electronic commerce. This is consistent with the overall approach taken in considering issues under CLERP. The following areas have been given particular emphasis.

Market Freedom

Competition plays a key role in driving market efficiency and increasing community welfare. It is important to ensure that regulatory interventions support and do not hinder the operation of the competitive process. The benefits that electronic commerce offers, and its increasing use across a wide range of markets, make it important that regulation does not impede the evolution of new electronic technologies and products. The regulation of electronic commerce, while providing for the protection of investors against unnecessary risk, should not be so heavy-handed as to impede market efficiency and competition.

Competition in financial markets has already resulted in the provision of cheaper and more varied services to consumers and the development of more efficient market practices, such as the more effective management of financial risk. The long term result of these developments will ultimately be increased investment and economic growth.

Investor Protection

A central theme of the Financial System Inquiry report was improving the efficiency and competition in the financial system without compromising its stability. Many of the recommendations designed to increase competition were premised on the introduction of world best practice in controlling the risks of disruption to the system.

Regulation should ensure that all investors have access to information regarding potential investment risks. The increased use of electronic commerce has implications for the security of investments. The implementation of real time gross settlement is expected to help mitigate systemic risks inherent in the payments settlement system.

However, as an inherently less visible form of trading, electronic commerce can raise concerns regarding the security of transaction processes. Concerns include whether the transaction has been accepted by the other party, and whether the details of the transaction remain confidential or can be accessed by outside parties.

A further potential concern for investors are the risks associated with international electronic transactions involving cross-border payments and securities settlements. Globalisation can help to reduce risks to investors by allowing them to diversify across a wider variety of investments in several countries. However, it is nevertheless desirable for other legal jurisdictions to effectively regulate their financial systems. These are issues being examined by other agencies and fall outside the scope of this paper.

Information Transparency

Efficient and competitive markets require potential buyers and sellers to have access to sufficient information to assess the potential risks and rewards of investments and thereby allow them to decide whether to proceed with transactions. Under Australia’s corporate law regime, the Australian Securities Commission (ASC) is empowered to act to promote the efficient provision of this information to potential investors.

Cost Effectiveness

The regulatory framework for business needs to take into account the direct and indirect costs which are imposed by regulation on business and the community as a whole. It is therefore important for the benefits, whether intangible or in the nature of the public good, to be weighed-up against these costs.

Regulatory Neutrality

Regulation for electronic commerce needs to recognise that there are a range of different technologies available for use by business to suit their various needs. It is important that the regulation is designed to be ‘technologically neutral’ so as not to directly influence the technology choices of business. Regulation should also be equally effective in meeting its aims, such as facilitating the fair transaction of goods and services, irrespective of the electronic commerce technology being employed.

Business Ethics and Compliance

The use of electronic commerce raises difficult issues for all nations regarding compliance and enforcement, given its use of non-physical means of conducting transactions. In particular, it offers the ability to transact business in ‘cyberspace’ ie outside the national boundary of the domestic regulatory authorities. This has implications for traditional jurisdictional control by the corporate and consumers affairs regulators, taxation agencies etc. It also raises issues of privacy.

Electronic Commerce in Context

In many ways, the impact of electronic commerce to date has been most strongly felt in the world’s financial markets. This is not surprising since much financial market activity takes the form of wholesale business-to-business transactions and it is business that is more likely to:

  • have invested in the technical infrastructure required for electronic commerce (although infrastructure costs are falling rapidly);
  • be comfortable with transactions which are not conducted face-to-face; and
  • be motivated by the need to reap efficiency benefits in their operations.

The combined effect of technological advances (particularly in computing and telecommunications), business innovation and financial deregulation have contributed to the increasing globalisation of international capital and product markets. The international integration of the markets for banking services, securities and derivatives has led to a profound transformation of financial flows. Capital and production are considerably more ‘footloose’ or mobile than in previous times. As the Financial System Inquiry noted, ‘[t]rading in many instruments is now global, reflecting the ability of technology to break dependence on physical location’. Ultimately, electronic linkages between markets could lead to their
aggregation, resulting in the emergence of regional or truly global securities markets. Such developments would raise complex issues of international recognition and co-regulation by national securities regulators.

Globalisation has coincided with higher levels of economic efficiency in domestic and international capital and product markets. Allocative efficiency has been enhanced as freer global capital markets facilitate the direction of savings to investments providing the highest returns, regardless of national boundaries. Capital can also flow more easily from developed countries to emerging economies, thereby presenting new opportunities for investors. Technical efficiency has been enhanced as outputs are produced at lower costs and transaction costs are reduced. Dynamic efficiency has been enhanced as the global provision of financial services allows firms to respond more quickly to changes in input costs, technology and consumer tastes.

Costs and Benefits

Globalisation of the world’s financial markets has already provided benefits to Australia in a number of different contexts. Australian investors now have increased choice and enjoy the opportunity to participate in foreign capital markets. Foreign companies, in turn, benefit through increased access to Australian capital, and add to the liquidity and depth of Australia’s domestic markets.

Electronic commerce offers the potential to further improve the efficiency of capital and product markets. Use of electronic commerce can reduce costs to both buyers and sellers, particularly those costs directly involved in completing the transaction. Harnessing developments in computer and communications technologies can reduce search costs by making it easier and quicker for buyers and sellers to find each other and pay for the goods or services provided. Such reductions in transaction costs, particularly for dealings between parties located in different countries, can be of a sufficient magnitude to foster trade. As the Financial System Inquiry noted:

‘International sales of financial services are not a new phenomenon. However, they have been restrained at the retail level by transaction costs. New technologies may reduce these costs, making it easier to provide financial services in many countries where the service provider does not have a physical presence.’

At the macroeconomic level, electronic commerce promises to provide a boost to overall economic growth in the medium to long-term, by improving market development and efficiency. The size of markets will expand as larger numbers of buyers and sellers are able to find each other and as the volume and value of cross-border transactions increase. Information on prices, usually the key factor in determining whether trade occurs, will become more readily available. As a result of these factors, it can be expected that the markets for many types of goods and services will expand and new markets will continue to emerge, providing more choice for consumers, as well as increasing the opportunities for producers to exploit economies of scale and scope.

As with most forms of structural adjustment, some costs will accrue, particularly in the short term. Firms will be required to outlay funds to acquire and maintain the means to engage in electronic commerce. Returns on these outlays may be small until such time as their customers and potential customers ‘find’ them through electronic means. Firms which do not make such investment however risk being left behind by the competition. On the other hand, there is considerable debate regarding the pace at which electronic commerce is likely to increase, with the more cautious warning that some smaller businesses may make the mistake of investing too quickly in the new technology. Central to this is whether growth in revenue from sales via electronic commerce is matched by growth in realised profits.

Electronic Commerce in Australia

Electronic commerce is already well established in Australia’s securities and futures markets. Automated systems for recording and storing information are an integral part of the operation of the capital market and provide the foundation for increasing reliance on electronic methods of transacting. The combination of the potential for electronic technology to offer efficiency gains, together with capital market demands for maximum efficiency, can be expected to continue to lead to the development of new technology to facilitate the operation of the market.

Systems in Australia’s securities and futures markets, such as SEATS, SYCOM, CHESS and the ASX’s foreshadowed Enterprise Market (EM), as well as the greater use of technology in Australia’s OTC markets have contributed to the reduction of transaction costs, in time as well as money. These systems are described at Appendix B.

New developments in payment systems offer the prospect of further reductions in costs, and hence increased efficiency. The widespread move to real-time gross settlement, the development of more legally certain regimes for the netting of market participants’ obligations, and the transaction of wholesale high-value payments across a number of separate systems owned and operated by the private sector (Austraclear) and the Reserve Bank of Australia (the RITS system), also promise to contribute to reduced transaction costs. Increased electronic trading in various Commonwealth and State government and private debt securities can be expected to do the same.

The Future

The rate of development of electronic commerce in the future depends upon businesses and, in the case of retail transactions, consumers, gaining access to appropriate facilities. This in turn depends on the costs of obtaining this access, and on businesses being confident that long term benefits to their marketing, customer service and sales opportunities will ensue. Another factor affecting the development of electronic commerce is confidence (or lack of it) in the security of the transaction process.

In the longer term, while Australian firms will benefit from improved access to international markets, foreign companies will also be better placed to compete for business here. Australian firms will come under increasing competitive pressures and will need to exhibit flexibility to cope with those pressures. The increase in competition for product markets may also force structural adjustments in the labour market.

Scope of this Paper

It is paradoxical that many of the issues affecting the development of electronic commerce in Australia’s financial markets and business community, that electronic commerce brings into focus, do not require dramatic changes to existing legal rules, while others require resolution across the whole legal system. This paper does not seek to provide answers to those latter issues, two of which, in particular, have the potential to greatly enhance confidence in electronic commerce and, hence, to expand electronic commerce opportunities across the whole economy. These issues (a national authentication framework and legal recognition of digital signatures), and other relevant policy work being undertaken elsewhere in government, are referred to in Appendix C.

This paper aims instead to canvass responses to matters within the Treasury portfolio where there is a role for government in either providing a more certain legal environment or removing legal or regulatory impediments to electronic commerce developments. It deals with many, but not all, of the electronic commerce issues arising in the Treasury portfolio. It does not, for example, canvass issues in the area of taxation, which is being addressed separately within the portfolio. Rather, the paper addresses high priority issues affecting financial markets and business identified in the reports of the Small Business Deregulation Task Force (by facilitating the emergence of a Single Entry Point for small business, as discussed in Part 4), and the Financial Sys
tem Inquiry and the Australian Law Reform Commission (by providing a more certain legal framework for netting arrangements, as discussed in Part 5). The paper also points to the need for ongoing review of a number of legislative and regulatory arrangements affecting business to ensure that they do not impede electronic commerce.

Corporate Law Economic Reform Program - Other Elements

This paper will not revisit electronic commerce issues that have been, or will be, canvassed in other papers issued under CLERP. In summary, those issues are as follows.

Fundraising

Electronic commerce provides new ways of engaging in fundraising activities. The review of the fundraising provisions of the Law, being undertaken as part of CLERP, examines ways the Law can be made more responsive to the use of electronic communication methods for corporations seeking equity from individual investors - see generally Part 4.3 of the CLERP Fundraising paper. Areas which have been considered are: the electronic lodgment of prospectuses; and the potential uses of electronic communication technology in the distribution of prospectuses and information about securities investments.

Under proposals advanced by the CLERP Fundraising paper, the ASC will be able to accept electronic lodgment of a prospectus, without requiring the separate lodgment of a paper version. The ASC will have to be satisfied that the electronic prospectus is in a format compatible with its information systems and that the prospectus can be securely distributed electronically, so that it cannot be altered.

The sharehawking prohibition would be limited to situations involving direct contact with potential investors, so that electronic distribution of prospectuses will be permitted under the Law.

Market Structures and Regulation

As already noted, electronic commerce, and technological developments generally, are changing the ways financial markets operate and are structured. For example, technology offers new ways for market participants to interact, or gives rise to new products. The futures and securities markets project being undertaken as part of CLERP will examine, inter alia, ways in which the Law should be amended so as to reflect the impact of technology on these markets and to ensure that the Law’s regulatory arrangements are appropriate, having regard to that impact.

Parliamentary Joint Committee on Corporations and Securities

The Parliamentary Joint Committee on Corporations and Securities is currently inquiring into the implications for the Law, the ASC and securities exchanges of global electronic capital raising and share-trading, focusing on the Law and equity-related securities. This is a welcome initiative that will promote public debate and understanding of the issues. The Committee’s recommendations will be carefully considered by the Government.


Enquiries concerning this paper and its implementation can be made to:

Mike Kooymans
Corporate Governance and Accounting Policy Division
The Treasury
Telephone: (02) 6263 3984