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2. Universal Licensing Regime

Date

Proposal

The Government invites comments on whether to apply a universal licensing regime to superannuation funds and, in particular, on the options:

  • of requiring trustees to hold an Australian Financial Services Licence (AFSL) to operate and issue interests in a fund (similar to the obligations on responsible entities of managed investment schemes); and/or
  • of requiring trustees to hold an APRA licence similar to the obligation on all other prudentially regulated financial institutions; and
  • relating to the form of minimum entry and operating standards that might be set by APRA.

The Background Issues Paper (released on 24 December 2001) characterised the licensing options as: Option 1 - an AFSL licence to operate and issues interests in a fund; Option 2 - an APRA licence; and Option 3 - for the trustee to hold both an AFSL and APRA licence.

Views from the consultation process

There was general support in submissions for a universal licensing regime for all superannuation funds. For example, AMP Limited stated that 'the safety of superannuation would be increased if all trustees were to be licensed (approved) as part of a broad risk based assessment of all managed funds.'

A number of submissions expressed concern that the need to hold two licences could lead to duplication and a blurring of the demarcation of responsibilities between APRA and ASIC. Many submissions (including those from the Australian Industry Group, the Coles Myer Superannuation Fund, CPA Australia, the Institute of Actuaries, the Law Council of Australia and the Industry Funds Forum) argued that there should be only one regulator issuing licences. Most indicated that as APRA was the body responsible for regulating the safety of superannuation, it should be the sole provider of a licensing system for superannuation trustees, although a few favoured an ASIC-only licence.

Submissions that did not support universal licensing focussed on concerns about the licensing of individual trustees and directors of corporate trustees (the Australian Council of Trade Unions) and not-for-profit corporate and industry funds. There was concern that licensing in such circumstances would diminish the opportunities for employee representation and reduce the diversity of trustees.

Some submissions also expressed concern about the potential costs of a licensing regime, particularly for smaller funds, and emphasised that licence criteria and the types of licence issued should take account of the nature of the trustee and types of funds being regulated. The Association of Superannuation Funds of Australia (ASFA) also flagged a need for better co-operation and information sharing between the regulators.

ASFA also emphasised the need to consider licensing within the broader regulatory framework, and indicated that '[t]he large number of funds means that licensing alone ... will have limited use and must be supported through strong on-going and ex-post supervision.'

During focus group sessions held in March 2002, participants indicated that the costs associated with requirements for an APRA licence should be quantified, and suggested that the SWG make it explicit whether restructuring is anticipated as an outcome of these reforms. Participants reinforced the need to avoid duplication and overlap of APRA and ASIC requirements with regard to the single entry point, and requested that the draft recommendations clarify that trustees have the ability to 'buy in' the expertise required to meet the licence criteria. The concept of a 'key person' licence requirement was suggested as a method of ensuring that the critical skills required to demonstrate competence to run the fund are retained by the trustees. Participants also requested clarification of the consequences of breaching the conditions of one licence (either the APRA licence or AFSL) where a trustee is subject to dual licensing.

As noted above, the SWG believes that it is more appropriate to cost the recommendations in consultation with all relevant stakeholders once they are fleshed out in greater detail in the development of the legislation.

Consideration of the proposal

Background

One of the key outcomes of the Financial System Inquiry (FSI) was the establishment of a 'twin-peaks' model for regulation of the financial services industry. Under this model, APRA is responsible for prudential regulation and ASIC for consumer protection and market integrity regulation.

Licensing is one of the regulatory tools that can be used to address both prudential and consumer protection issues. In establishing the twin-peaks model, the FSI envisaged that both APRA and ASIC would have licensing systems available to them. However, the licence criteria would differ depending on the regulatory aims that the particular licence is directed at. The FSI noted that there would need to be close co-operation between the regulators.3

A licensing system under which one regulator, such as APRA, is solely responsible for licensing to address both prudential and consumer protection issues would be inconsistent with the regulatory framework that has been established following the FSI.

Dual licensing already exists for many Approved Trustees. Following the commencement of the Financial Services Reform Act 2001 (FSRA) on 11 March 2002, it also exists for many other APRA-regulated bodies, including Authorised Deposit-taking Institutions (ADIs) and insurance companies. As noted above, the APRA and ASIC licences are addressed at different regulatory aims and this is reflected in the licence criteria. In some cases, similar requirements will apply, such as competency, but for different regulatory purposes. Consideration needs to be given to whether the requirements for one regulatory purpose can be taken to be sufficient to meet those imposed for the other regulatory purpose. For example, under the FSRA, licence criteria addressed at the adequacy of resources and risk management systems are not required to be met by APRA-regulated bodies on the basis that APRA's requirements already address these criteria completely.4

For other criteria, it may not be possible to say that the assessment by one regulator completely addresses the regulatory purposes of the other regulator. For example, an assessment by APRA that an institution is 'fit and proper' to be an ADI, while relevant, may not fully address ASIC's assessment of whether the institution is competent in its dealings with individual customers. In such circumstances, it may be appropriate for one regulator to have regard to an assessment made by another, without making it determinative.

APRA licence

While it would be inconsistent with the post-FSI regulatory framework to have a licence directed towards both prudential and consumer protection issues administered by a single regulator, there remains a question of whether licences are necessary to address both of these regulatory aims. Option 1 in the Background Issues Paper, an AFSL alone, was premised on the assumption that a consumer protection licence might be sufficient and that no further licensing was needed to address prudential issues. As noted in the Issues Paper, however, such a licensing regime would not obviate the need for increased prudential oversight of smaller funds. The issue is whether a prudential licence is necessary to provide for that increased oversight, or whether it can be achieved in other ways.

In subsequent recommendations, the SWG, with support from a significant number of submissions, sees an important role for risk management plans in addressing prudential regulatory issues. While a risk management plan could be a stand-alone requirement, experience under the Managed Investments Act 1998 (MIA) regime is that compliance plans work extremely effectively as part of a licensing regime. Similarly, while it would be pos
sible for one regulator to assess licensing and another to assess the risk management plan, outcomes are more likely to be better co-ordinated and more cost effective for both the regulators and the industry if the same regulator that assesses licensing also assesses the risk management plan requirements.

The role of the risk management plan envisaged by the SWG is largely aimed at demonstrating how the trustee intends to deal with the key risks associated with investment, outsourcing, governance and risk management issues. These are largely matters of more significance to the prudential regulator than they are to the consumer protection regulator. In light of this, the SWG believes that it is not appropriate solely to have a consumer protection licence, but that licensing is also necessary for prudential purposes. Thus the SWG does not favour Option 1 and believes that trustees of superannuation funds should be required to be licensed by APRA.

Recommendation 1

The SWG recommends that trustees of superannuation entities (other than self managed superannuation funds (SMSFs) or exempt public sector superannuation schemes (EPSSSs)) be licensed by APRA. To obtain such a licence, a trustee should be required to:

  • comply with conditions on a licence, with other legislative requirements and with the covenants in the trust deed;
  • have adequate resources in place (financial resources (see discussion on capital under 6.1), technological and human resources);
  • meet minimum standards of competency;
  • have adequate risk management systems in place, including a risk management plan and adequate arrangements for ensuring compliance with the plan;
  • have adequate levels of professional indemnity insurance and material damage/consequential loss insurance in place;
  • have adequate outsourcing arrangements in place; and
  • meet any other conditions as prescribed in regulations or as required by APRA.

Licensees would also need to meet these licence criteria on an on-going basis.

The SWG recommends that the Government consider enforcement powers to enable APRA to suspend or remove a trustee or to revoke its licence where the trustee breaches the conditions of its licence or where an existing trustee fails to obtain a licence from APRA.

As suggested in the Background Issues Paper, the SWG considers that it should be the corporate trustee, or in the case of individual trustees, the 'notional trust entity' that is licensed.5 Thus each individual trustee would not be required to meet the licence criteria in their own right, but rather the trustee entity as a whole must satisfy the licence criteria. The licence might also include a 'key person' condition to require an individual who holds the critical skills necessary to demonstrate competence to operate the fund to continue to be involved in running the fund. These initiatives should address concerns that licensing might diminish the opportunities for employee representation and reduce the diversity of trustees.

Further, the SWG considers that, consistent with the approach that ASIC is taking with AFSLs, trustees should be able to outsource the satisfaction of the licensing obligations to third parties. For example, the trustees could 'buy in' the expertise to show the competence to operate the fund. However, the trustees would be required to satisfy the regulator that they have appropriate systems in place to manage any outsourced functions.

Recommendation 2

The SWG recommends that the licence apply to either the trustee corporation as a whole, or where the trustee is comprised of individuals and no corporate trustee structure exists, to a 'notional entity' comprising those individuals. The SWG further recommends that the Government consider mechanisms to ensure that trustees as a whole are able to show the capacity to meet the licence criteria. This would include enabling the trustees to 'buy in' the expertise to demonstrate the competence to operate the fund, or through the application of 'key person' licensing conditions.

In addition to licensing superannuation trustees, the SWG believes that there would be considerable merit in requiring trustees to register with APRA each of the funds for which they act as trustee. One of the regulatory difficulties identified by APRA is that a fund can be started up without APRA having any prior notice. APRA only becomes aware of the existence of the fund when an election is made under section 19 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) to be a regulated fund for the purposes of that Act. That notice is required to be given within 60 days of the fund being established.

By contrast, under Part 5C of the Corporations Act 2001 (Corporations Act), in addition to the responsible entity of a managed investment scheme being required to be licensed, each managed investment scheme must also be registered with ASIC and a compliance plan must be lodged for each scheme. This registration process gives ASIC the opportunity to ensure that the responsible entity is appropriately licensed, that it will be able to comply with its obligations in relation to the particular scheme, that the conditions on its licence remain appropriate for that scheme and that it has a compliance plan for that scheme.

The scheme registration process itself is not as detailed as the licensing process. It requires the lodgment of the scheme's constitution, the compliance plan and a statement signed by the directors that the constitution and compliance plan meet the requirements of the law. ASIC must register the scheme unless the responsible entity is not appropriately licensed or the constitution and compliance plan do not meet the requirements of the law.

It would not be possible for the trustees of superannuation funds to register funds prior to commencement of operations, since until contributions (trust property) are made to a fund, a fund does not exist as a trust. Thus, in relation to superannuation funds, the SWG considers that trustees should be required to provide notice of an intention to establish a fund. It should be a requirement that trustees cannot accept contributions into a fund unless the fund is registered. Consideration will also need to be given to how the requirement to register a fund would operate in the context of the current requirement to notify of intention to be regulated under the SIS Act within 60 days. It may be that the latter requirement can be brought forward to the time of registration of the fund.

The SWG suggests that as a component of this registration or notification of intention process, trustees should be required to lodge the trust deed and a risk management plan (see discussion of requirements in Chapter 3 of this report indicating why the SWG is recommending development of a 'risk management plan' rather than a 'compliance plan'). The trustee should also be required to lodge certification that the trust deed and risk management plan comply with relevant requirements.

It was noted by some during the consultation process that it may be difficult to prepare a detailed risk management plan for start-up funds, as the full details of proposed operations will not be known prior to the commencement of operations. It was suggested that a truncated plan be lodged at that time, with a detailed plan being lodged after the fund had been in operation for some time. The SWG believes that it is appropriate for trustees to lodge a full risk management plan on commencement, but believes that consideration will need to be given to whether trustees should be required to submit a revised risk management plan at a later date (for example, to coincide with the first inspection by APRA), or whether the trustee would be required to submit a new risk management plan to the regulator each time it is changed significantly. Regardless of lodgment
requirements, the SWG envisages that risk management plans will be living documents that will be adjusted and modified as necessary to address changes in fund operations.

Recommendation 3

The SWG recommends that licensed trustees be required to register with APRA an intention to establish all funds they propose to operate prior to commencement. As a component of this registration process, trustees should be required to lodge the trust deed and a risk management plan, and certification that the trust deed and risk management plan comply with relevant requirements.

Recommendation 4

The SWG recommends that existing trustees be given up to two years from the date of commencement of legislative amendments to apply for a licence and to register existing funds. New trustees would be required to be licensed from the date of commencement of the licensing regime. Consideration will need to be given to how the licensing process can be smoothed administratively during the transitional period to ensure that a significant number of applications are not received at the end of the two year period.

ASIC licence

Option 2 in the Background Issues Paper, an APRA-only licence, implied that licensing was not necessary for consumer protection purposes and that a prudential licence would be sufficient, with consumer protection aims being achieved in other ways. As noted above, the licence criteria for an ASIC licence are directed towards consumer protection aims. Such a licence has been in place for trustees of some superannuation funds under the former Corporations Law (now Corporations Act) since the SIS Act was introduced, and following the commencement of the FSRA will be extended to a wider range of APRA-regulated bodies. As a consumer protection measure, licensing has long been considered a necessary regulatory tool in the financial services industry to impose minimum entry levels. The SWG does not consider that it would be appropriate to remove outright the current consumer protection licensing regime for superannuation trustees.

Option 3 suggested dual licensing by APRA and ASIC, in recognition of the fact that licensing can address both prudential and consumer protection issues. The SWG is of the view that this is the appropriate outcome consistent with the post-FSI regulatory framework. It is also consistent with the recommendation of the Productivity Commission in its draft report, Review of the Superannuation Industry (Supervision) Act 1993 and Certain Other Superannuation Legislation, that superannuation entities be licensed by APRA subject to specific conditions.6

However, the SWG is conscious of the need to avoid regulatory overlaps that might impose undue costs on industry and, in turn, fund members. In view of this, the SWG does not believe that the ASIC licence should be extended to the operation of the fund, but should only apply to dealing in and/or advising on interests in the fund. This differs from the approach under the Corporations Act for managed investment schemes, the responsible entity of which is required to be licensed to operate, deal and advise. However, managed investment schemes are not subject to any prudential regulation, thus to achieve consumer protection aims it is important that the licensing requirements also address the entity's ability to operate the fund. Nonetheless, in considering the dealing activity of trustees in superannuation funds, ASIC will consider many matters that are also relevant to the operation of the fund.

Recommendation 5

The SWG recommends that the requirement for an APRA licence be in addition to the FSRA requirements to have an AFSL to advise or to deal in interests of the fund. However, a trustee should not be required to have an ASIC licence to operate the fund.

There is also a question of whether it is appropriate to continue the FSRA exemption for non-public offer funds dealing in interests in the fund. Under the FSRA, such funds will only require an AFSL for advising on interests in the fund.

While the precise number of trustees that will be licensed under this requirement is not known at this stage, it is likely that some trustees of non-public offer funds will require an AFSL. Those trustees that will be licensed will be required to have in place compensation arrangements to cover loss or damage as a result of breaches of the law in relation to their advising activity. However, there will be no requirement for compensation arrangements for loss or damage suffered as a result of problems in the issuing of interests. Thus there will be a gap in the coverage of compensation arrangements in relation to dealing activity by trustees of non-public offer funds.

Given that the SWG is recommending that these trustees obtain an APRA licence and will be required to meet standards of competence and other licence criteria, it may not be a significant additional burden for such trustees to also obtain an AFSL to deal. This is particularly so given the recommendations that the SWG is making in relation to a single entry point and avoiding overlaps.

If it is not considered appropriate to require trustees of such funds to have an AFSL, the SWG believes that such trustees should be required to have compensation arrangements in place (perhaps as a condition of their APRA licence) to cover loss or damage suffered as a result of problems in issuing interests. However, it should not be necessary for APRA to establish its own procedures for determining the adequacy of compensation arrangements in relation to such activities. Under the FSRA, ASIC is already required to assess the adequacy of compensation arrangements. APRA could rely on ASIC's assessment of the adequacy of compensation arrangements in determining whether trustees have appropriate compensation arrangements.

Recommendation 6

The SWG recommends that the Government review the exemption from the AFSL requirements for dealing by trustees of non-public offer superannuation funds.

Single entry point

As noted above, the SWG favours both prudential and consumer protection licences, which for some trustees will mean both an APRA and ASIC licence. The SWG is conscious of the need to reduce compliance costs to the greatest extent possible and to avoid overlaps in the licence criteria. While dual regulators of the financial services industry are a necessary consequence of the FSI 'twin-peaks' model, the SWG recognises that for superannuation in particular there may be a need to ease the burden of having to deal with two regulators for the same business. Unlike other prudentially regulated sectors, there is a much wider diversity in size and type of trustees in relation to superannuation. For the smaller non-public offer funds in particular, having to deal with two licensing processes may be a significant burden.

The SWG considers that the Government should explore the possibility of providing a single entry point for licensing of superannuation trustees by APRA and ASIC. The SWG is of the view that, if it is feasible from a systems perspective, it would be appropriate for trustees to apply to one regulator and include in that application process all of the information required for both the APRA and ASIC licences. Thus, at least at the initial licensing stage, applicants would have a single interface with the regulators. Further into the licensing process, applicants will, of course, have to deal with both regulators, particularly when conditions are imposed on the licence. The SWG believes that further work should be done by the regulators in making the dual interface as user-friendly as possible.

Regard will need to be had to the existing processes that the regulators have in place (including the new e-licensing system that ASIC has established for the FSRA), the costs of establishing a new system and the benefits to industry of a single entry point process.

In addition to considering arrangements for str
eamlining the licensing process, the SWG also believes that there are a number of areas in which overlaps in the licence criteria should be specifically addressed in the legislation. In particular, as noted above, under the FSRA, APRA-regulated bodies are not required to meet the requirements for adequate resources and risk management systems as part of their AFSL. The SWG believes this is appropriate and should apply to superannuation trustees who will be required to have both an APRA and ASIC licence.

Further, the SWG believes that there is scope for the regulators to take into account each other's assessments in relation to the other licence criteria. Both regulators will be required to assess trustees' competence. However, they will be assessing competence for different activities. APRA will be assessing trustees' competence to operate a fund in a prudent manner, while ASIC will be assessing trustees' competence to deal in and/or advise on interests in a fund. While the activities are different, many of the matters that each regulator will take into account in assessing competence may be similar.

The SWG does not believe that it is appropriate for ASIC to have regard definitively to APRA's assessment of competence. However, it believes that ASIC should be required, as a matter of law, to have regard to APRA's assessment of competence.

Recommendation 7

The SWG recommends that the Government consider streamlining arrangements for trustees required to hold both an APRA licence and an AFSL, through the development of a single entry point enabling trustees to lodge only one application to cover both licences. The single entry point would only apply to applications for an APRA licence and AFSL submitted after commencement of the APRA licensing requirements. The application would need to contain sufficient information to meet the requirements for both licences. In considering this recommendation, the SWG suggests that the Government examine:

  • the matters that ASIC should consider when licensing an entity that has been or is to be licensed by APRA;
  • the extent to which the regulators should be required to consult with each other in taking licensing action; and
  • the memorandum of understanding that establishes information-sharing arrangements between APRA and ASIC.

Implementation issues

While the SWG has been conscious of minimising the compliance costs of licensing to the greatest extent possible, it may be that for some smaller funds the compliance costs of licensing, together with the other obligations being recommended by the SWG, make it uneconomic to continue to operate.

One avenue for enabling smaller funds to continue to operate without the cost of regulation by APRA may be for them to move into the SMSF regime administered by the ATO. However, the current threshold for SMSFs may be an impediment to some funds being able to move out of the APRA regime. The SWG believes that there may be some merit in reviewing the threshold for SMSFs. Such funds could restructure if necessary and move to the ATO regulatory regime. The Small Independent Superannuation Funds Association has suggested that the test should be based on whether there are any arm's length members, rather than on a particular number (currently fewer than five).

A recent breakdown of APRA-regulated funds in terms of numbers of members (at Table 2.1) shows that a large number of APRA-regulated superannuation funds (over 8,000) have fewer than five members, but for whatever reason, these funds do not fall within the SMSF definition. By comparison, only just over 1,100 funds fall within the next two categories (funds with five to nine members, and funds with 10 to 19 members). There are just over 500 funds in the 20 to 99 member category.

Table 2.1 suggests that a quantitative change alone to the SMSF test to increase the number of members who would also be trustees of the fund would not result in substantial numbers of funds moving out of the APRA regulatory regime. Rather, changes to the SMSF definition would need to be of a qualitative nature. The SWG recognises that this is a sensitive issue, but believes that it is one that is worthy of consideration to assist smaller funds in adjusting to the new regulatory regime. What will need to be determined is whether there is a more appropriate test for assessing which funds should be subject to prudential regulation and which ones do not need the same kind of intensity of regulation.

Table 2.1: APRA-regulated funds according to number of members at March 2002

Category of fund

Number of funds

Fewer than five members

8,121

5-9 members

864

10-19 members

275

20-99 members

506

More than 100 members

1,306

Total

11,072

Source: APRA, 2002.

Further, there are currently provisions under the SIS Act facilitating the transfer of assets to successor funds. The SWG has not considered these provisions in detail, but considers that the Government should review them to ensure that there are no unnecessary impediments to the winding up and transfer of fund assets for those trustees that do not wish to operate under the new regulatory regime.

Recommendation 8

The SWG recommends that the Government consider:

  • the current threshold for SMSFs to determine whether it is an appropriate test for determining which funds require prudential regulation; and
  • whether the existing successor fund provisions contained in the SIS Act are appropriate to deal with any restructuring that may occur as a result of the new licensing requirements.

3 Financial System Inquiry 1997, paragraph 8.3.

4 Paragraph 912A(1)(d) of the Corporations Act 2001 inserted by the FSRA.

5 Superannuation Working Group 2001, Options for Improving the Safety of Superannuation Background Issues Paper, Canberra, December, pp. 5-6.

6 Productivity Commission 2001, Review of the Superannuation Industry (Supervision) Act 1993 and Certain Other Superannuation Legislation, Draft Report, Canberra, September, Draft Recommendation 7.1.