The purpose of this Chapter is to discuss a number of issues that would be relevant to the construction of a broad statutory scheme. These include who should operate the scheme and its funding. (A number of these issues apply equally to exchange-related compensation funds.)
The inclusion of this section should not be viewed as indicating that the Government has decided that any statutory scheme is warranted. If that decision were reached, then each of these issues would have to be examined in greater detail.
242. The possibilities considered in the CASAC Consultation Paper63 are:
- licensed market operators;
- clearing and settlement facility licensees;
- intermediaries collectively (for example, through a mutual entity of which all intermediaries are members);
- it is very difficult to conceive of all intermediaries, let alone all financial services licensees, voluntarily forming such a body;
- an `independent entity' that operates the scheme in accordance with legislative criteria and/or regulations;
- for example, an existing ASIC-approved external dispute resolution scheme operator.
This proposed solution has the advantage of avoiding the need for a new and costly administrative structure, and the CASAC Consultation Paper suggests it would provide retail clients with access to the one entity that could deal with their investment complaints against an intermediary, whether solvent or insolvent.
- for example, an existing ASIC-approved external dispute resolution scheme operator.
- the criteria to be applied, and the nature of the decision to be made by the external dispute resolution operator would change on insolvency;
- there are a number of external dispute resolution schemes based on different segments of the financial services sector;
- a financial services licensee may be required to be a member of more than one scheme;
- it would appear inappropriate to choose one such scheme to operate any statutory compensation fund (and requiring financial services licensees to be members of a particular private body may raise competition issues).
To provide for a series of external dispute resolution scheme operators to operate any statutory compensation scheme would involve administrative difficulties - for example, who would have the power to levy, and ensuring consistent administration.
One suggestion, which has been made to meet these concerns, is to give the levy power and the power to make rules and set the policy to a statutory agency that would delegate the day-to-day decision-making functions to the individual external dispute resolution schemes.
243. The SEGC has also been suggested, again with the aim of avoiding the need to create a new apparatus. However, it is a wholly owned subsidiary of the Australian Stock Exchange with a very specific current role.
Secondary issue 12
If a statutory scheme were warranted, who should operate the scheme?
244. If a statutory scheme is considered warranted, there are obviously a large number of reporting and governance issues. Their treatment will, in part, depend on the nature of the scheme operator. They include:
- Should there be any special reporting requirements, bearing in mind any power to levy to provide a compensation fund (see below) and holding such funds?
- How would its governing body be constituted?
- it has been suggested that it would be necessary to include persons with investor experience and appropriate corporate governance/public administration experience in addition to financial services representatives;
- one submission to CASAC suggested that practitioner representatives would provide practical day-to-day experience, knowledge and insight as well as a sense of responsibility for and commitment to effective regulation;
- it would, however, be unfortunate if such members saw their role as representatives of a particular group or industry sector, rather than as upholding the wider public interest;
- should the market operators be involved?
- What appeal rights are appropriate?
Secondary issue 13
If a statutory scheme were warranted, what special governance and accounting requirements would be appropriate?
245. The aim of the Financial Services Reform regime is to provide a harmonised regulatory regime across the range of the financial services.
246. Whether the compensation regime should apply to all financial services is a separate issue and is discussed at paragraphs 124 and 125.
247. Whatever the range of financial services decided on, this does not mean that there should not be variations within the scheme to accommodate the different ways that business is done across the financial services industry, the different risks involved, or the recognised segments of the industry.
248. Issues in this context include:
- should financial service licensees who are intermediaries be treated in a different manner to those who are issuers?
- should financial services licensees who are market participants be put into a separate sub-scheme?
- one submission to CASAC suggested a network of sub-schemes for groups such as ASX participating organisations, SFE members, financial planners etc.
- alternatively ASX participating organisations and members of other exchanges could remain under their current compensation regimes, and the statutory scheme only apply to other financial services licensees;
- should any scheme be limited to on-market transactions, as one submission to CASAC suggested?
249. However, any proposal relating to sub-schemes needs to recognise that:
- any financial services licensee may be offering a wide range of products;
- there will ultimately be difficulties about categorising particular products;
- the focus should be on the service (and the comparability of the service), rather than on the financial product;
- division in accordance with recognised segments of the industry may not address concerns about cross-subsidisation;
- even though a particular financial product is risky, this does not necessarily mean that provision of a financial service in relation to it is high-risk conduct. Instead, it may be that particular conduct (such as advising) is the source of more claims than, say, execution-only transactions.
Secondary issue 14
If a statutory scheme were warranted, could the one scheme cover financial services in relation to all financial products and sectors of the industry?
D: How would it be funded?64
250. How would the scheme initially be funded?
251. The CASAC Consultation Paper65 stated: `Transitional arrangements could deal with the transfer of appropriate funds currently held by the National Guarantee Fund and the SFE to the new Scheme. A substantial transfer could benefit intermediaries by reducing their immediate or foreseeable levies, as well as providing immediately available funds on commencement of the Scheme.'
252. In response to the CASAC suggestion, various
concerns were raised in two submissions about applying the National Guarantee Fund to support the scheme during the transitional period :
- appropriating National Guarantee Fund trust money may be unconstitutional as an acquisition of property on other than just terms;
- the proposal may delay or prevent the ASX's intended application for the clearing guarantee element of the Fund;
- the proposal does not take sufficient account of the National Guarantee Fund's role in protecting wholesale investors or providing funds for projects relating to the development of the securities industry;
- the bodies that are to provide the clearing guarantee and the securities industry development account have a higher claim on National Guarantee Fund funds than the proposed scheme, which should be funded by industry;
- funds from the National Guarantee Fund could be used to benefit persons who cannot claim on, and have not contributed to, the National Guarantee Fund, and would involve cross-subsidisation;
- payment from the National Guarantee Fund may not be necessary to ensure adequate funding for the Scheme, given that claims can only be made in the event of an intermediary's insolvency and such insolvencies are infrequent.
253. A different view may be taken if the statutory scheme were limited to market transactions or market participants.
254. Another submission to CASAC expressed the view that the transitional arrangements should cover transfer of technology, personnel, procedures and expertise as well as funds, to ensure a seamless and reliable handover.
Secondary issue 15
If market licensees were no longer required to make compensation arrangements, what should happen to the funds in the National Guarantee Fund and the exchange fidelity funds?
255. Ongoing funding could be provided by some combination of the following:
- interest on trust accounts held by financial services licensees (although this interest is retained by the licensee under the new Chapter 7 regime66);
- levies (which would be in addition to the fees currently payable to ASIC and the levies due to APRA).
256. In the case of levies, further issues arise:
- the levy could be on transactions, on licensees according to their gross revenue from acting on behalf of retail clients or all clients, or be based on the number of employees and representatives providing financial services;
- should licensees be divided into classes, with different levies set depending on risk (including the level of prudential supervision)?
- The problem is to match risk in the financial services provided by a particular licensee to the scheme on the one hand, and the rate of the levy on that licensee.
- should market licensees also be required to contribute, given that they would benefit from the scheme?
- if market licensees are no longer required to have compensation arrangements, then should the levy payable by market participants be paid instead from the relevant current market compensation fund?
257. Licensees could be levied as and when required, or on a more regular basis with the purpose of creating a reserve and minimising unexpected calls.
258. One submission to CASAC suggested that it may be appropriate to use some or all of the levies collected to purchase insurance rather than being invested by the Scheme operator. This would `outsource' the funding of the Scheme and may obviate the need for the Scheme to build up sufficient funds to cover a `one year in fifty claim' on the financial failure of a major intermediary or to unduly cap claims in a period of stress.
259. Note that the Government expects any such scheme to be totally industry-funded.
Secondary issue 16
If a statutory scheme were warranted, how should it be funded initially and in the longer run?
E: What should be its statutory powers?67
260. Should the operator have any prudential powers? The CASAC Consultation Paper discussed this possibility, and came to the conclusion that it was not appropriate.
261. Further, submissions to CASAC made the following points:
- the exchanges and clearing houses already have prudential powers and it is not necessary for the Scheme operator also to have these;
- ASIC already has relevant powers and in general has exercised them effectively. There is no need for a further layer of regulation on financial intermediaries.
262. There is also the question of the non-prudential powers of the scheme operator.
263. CASAC expressed the view that the scheme operator would need:
- sufficient powers to perform its duties - for example;
- to ensure that intermediaries contributed to the scheme;
- to invest any surplus;
- to obtain information from relevant persons and/or enter into information sharing agreements with relevant regulators to gain access to sufficient information regarding any failed intermediary and its client accounts;
- qualified privilege and protection for breach of confidentiality;
- power to transfer client accounts of an insolvent intermediary to another intermediary and to close out open positions in derivatives contracts, `though exercise of these powers should be co-ordinated with comparable powers of liquidators, financial market operators and regulators'.
264. While the first two dot points above appear unexceptional, the power in the third would need careful consideration before adoption. The current roles of clearing houses, external administrators and receivers need to be respected.
Secondary issue 17
If a statutory scheme were warranted, what would be the appropriate powers of the operator?