House of Representatives

Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Scott Morrison MP)

Chapter 1 - Overview of crisis management

Outline of explanatory memorandum

1.1 The Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 (the Bill) provides the Australian Prudential Regulation Authority (APRA) with an enhanced suite of crisis resolution powers applicable to prudentially regulated authorised deposit-taking institutions (ADIs), general insurers and life insurance companies (insurers), and certain group entities.

1.2 Chapters 2 to 9 deal with amendments to powers relevant to the resolution of a regulated entity in distress. These are specifically APRA's powers in relation to:

·
statutory and judicial management (Chapter 2);
·
directions powers (Chapter 3);
·
transfer powers (Chapter 4);
·
conversion and write-off of capital instruments (Chapter 5);
·
stay provisions (Chapter 6);
·
foreign branches (Chapter 7);
·
Financial Claims Scheme (Chapter 8); and
·
wind-up and other matters (Chapter 9).

1.3 Chapter 10 deals with amendments that relate to crisis resolution planning, to provide APRA with clear powers to ensure that regulated entities are better prepared for a resolution prior to such an event arising.

Context of the Bill

1.4 The global financial crisis demonstrated that, when complex financial groups enter distress, failure to resolve these entities in an orderly fashion can lead to severe adverse economic consequences. To achieve effective resolution, it is essential for regulators to have access to flexible, timely and robust resolution powers. When dealing with complex groups, it is often not sufficient to apply powers to the regulated entity alone. Critical services (such as information technology, financial positions or essential staff) may be located in other group entities and contagion effects can occur within groups. Regulators need to be able to move swiftly to safeguard the critical operations of these entities where the need arises.

1.5 Just as important as the adequacy of the powers is the legislative context in which those powers are exercised. Regulators and key stakeholders such as directors, senior managers and administrators need to be confident that actions taken in good faith in pursuit of a resolution cannot be unwound, and that the stakeholders implementing said actions will be protected from adverse consequences.

1.6 Likewise, depositors, policyholders, taxpayers, shareholders and creditors require a legislative framework for resolution that meets the objectives of regulators and preserves value in distressed institutions, whilst maintaining to the extent possible the structure of commercial bargains struck prior to resolution. However, to achieve this, regulators and government will sometimes require space in which to properly understand the nature and extent of the problems facing a distressed institution, and time in which to fashion a solution. As such, regulators need to be able to conduct their work confidentially (where appropriate) and without being frustrated by pre-emptive actions by counterparties of the distressed institution. Where resolution has an adverse impact on counterparties such as creditors (relative, for instance, to ordinary insolvency), those counterparties ought to be confident that they will be compensated appropriately.

1.7 As well as flexible, timely and robust resolution powers, it is important regulators have clear powers to set appropriate prudential requirements for resolution planning, and to address potential barriers to the orderly resolution of regulated institutions and groups, prior to any crisis occurring.

1.8 Following the global financial crisis, from 2008 to 2010, the then Government introduced a series of legislative reforms to enhance prudential regulation and consumer protections, including the Financial Claims Scheme (FCS).

1.9 In 2012, the then Government issued a consultation paper, 'Strengthening APRA's Crisis Management Powers' (2012 Consultation Paper), which canvassed a large number of proposals as part of an ongoing review of APRA's crisis management powers. These proposals sought to address the identified gaps and areas that could be strengthened with reference to domestic and international developments at the time.

1.10 The 2012 consultation process was put on hold pending the outcome of the 2014 Financial System Inquiry (FSI).

1.11 The Final Report of the FSI, delivered in December 2014, recommended that the Government complete the process for strengthening APRA's crisis management powers (Recommendation 5). In its response to the FSI, the Government agreed that regulatory settings should provide regulators with clear powers in the event that a prudentially regulated financial entity or any part of the financial market infrastructure (FMI) fails [1] .

1.12 The Government has prioritised the implementation of the crisis-oriented proposals in the 2012 Consultation Paper for APRA in relation to prudentially regulated ADIs and insurers. The Government has also prioritised the implementation of key proposals from consultations on the contractual loss absorption provisions in regulatory capital instruments in 2014 and on the FCS in 2011.

1.13 The proposals in the 2012 Consultation Paper were prepared to reflect international developments in financial regulation following the global financial crisis, particularly the work in the G20 and by the Financial Stability Board (FSB) to promote resilient financial systems and frameworks to resolve financial distress.

1.14 Since 2012, the G20 and FSB have continued to progress this work, including updating the FSB's Key Attributes on Effective Resolution Regimes (Key Attributes) in 2014 to address sector-specific considerations for insurance and FMI. The Basel Committee on Banking Supervision (BCBS) and the International Association of Insurance Supervisors (IAIS) have also taken steps to further address crisis preparedness in their core principles for the supervision of banks and insurers. The proposals in the Bill help to provide a framework for resolution that is consistent with these international developments, in a manner that is appropriate for the Australian financial system. In a cross-border context, the proposals in the Bill help ensure APRA has resolution powers which could be applied in a coordinated manner with authorities in other jurisdictions, where relevant, consistent with the Key Attributes.

1.15 Other proposals in the 2012 Consultation Paper that were less resolution-centric and those relating to FMI will be progressed separately. Similarly, while the Government has also agreed to consider other important crisis-related reforms, such as the implementation of a requirement for additional loss absorbing capacity (Recommendation 3 of the FSI's Final Report), that work is being progressed separately to these reforms.

Summary of new law

1.16 The Bill amends the Banking Act 1959 (Banking Act), Insurance Act 1973 (Insurance Act), Life Insurance Act 1995 (Life Insurance Act), Australian Prudential Regulation Authority Act 1998 (APRA Act), Payment Systems and Netting Act 1998 (PSN Act), Financial Sector (Business Transfer and Group Restructure) Act 1999 (Transfer Act), Corporations Act 2001 (Corporations Act) and Income Tax Assessment Act 1997.

1.17 For the purposes of this Bill, the Banking Act, Insurance Act and Life Insurance Act are collectively referred to as the Industry Acts.

1.18 The Schedules to this Bill make amendments in relation to crisis resolution to:

·
enhance APRA's statutory and judicial management regimes to ensure their effective operation in a crisis;
·
enhance the scope and efficacy of APRA's existing directions powers;
·
improve APRA's ability to implement a transfer under the Transfer Act;
·
ensure the effective conversion and write-off of capital instruments to which the conversion and write-off provisions in APRA's prudential standards apply;
·
enhance stay provisions and ensure that the exercise of APRA's powers does not trigger certain rights in the contracts of relevant entities within the same group;
·
enhance APRA's ability to respond when an Australian branch of a foreign regulated entity (foreign branch) may be in distress;
·
enhance the efficiency and operation of the FCS and ensure that it supports the crisis resolution framework; and
·
enhance and simplify APRA's powers in relation to the wind-up or external administration of regulated entities under the Industry Acts, and other related matters.

1.19 Schedules 1 to 3 to this Bill also make amendments to the Industry Acts to ensure that APRA has clear powers to make appropriate prudential standards on resolution planning and ensure that regulated entities and their groups put in place measures to improve their preparedness for resolution.

Detailed explanation of new law

1.20 The Bill gives APRA an enhanced set of powers for crisis resolution and resolution planning in relation to regulated entities.

Crisis resolution

Statutory and judicial management

1.21 The existing statutory and judicial management regimes in the Industry Acts represent important powers for dealing with a financial institution in acute distress. APRA may need to use these tools to take control of an entity in cases where it does not have confidence that the board and management is capable of resolving a crisis satisfactorily, or where the board and management are mismanaging the entity, including where it is insolvent or near insolvent. Given the importance of these powers, particularly as a measure of last resort, certain key enhancements are proposed to ensure their effective operation in all relevant situations.

1.22 These enhancements include ensuring the statutory management tool can be applied in a group context where necessary. The structures of financial groups can be complex, involving numerous business lines and support services linked through different ownership and contractual arrangements. In the absence of effective group resolution powers, it may be particularly difficult to resolve a distressed regulated entity or group quickly and effectively.

1.23 A further enhancement is to extend the statutory management regime to insurers in certain defined circumstances. In most situations, applying to the Court for the appointment of a judicial manager is likely to remain the appropriate resolution tool for a failing insurer. However, there may be specific situations where APRA needs the ability to appoint a statutory manager to an insurer. In particular, this could be the case where the insurer is large or part of a complex financial group, or its distress poses a risk to the financial system or economy.

1.24 This Bill enhances APRA's capacity to take control of a distressed ADI or insurer and/or relevant parts of its group, subject to certain pre-conditions and safeguards, including amendments to:

·
enhance APRA's statutory management powers in respect of ADIs, including new statutory management powers in relation to foreign ADIs;
·
provide APRA with new statutory management powers in respect of insurers;
·
provide APRA with new statutory management powers in respect of authorised non-operating holding companies (NOHCs) of regulated entities, and domestically incorporated subsidiaries of authorised NOHCs or regulated entities;
·
enhance the moratorium provisions with respect to the statutory and judicial management provisions of the Industry Acts; and
·
enhance the statutory immunity provisions applying to statutory and judicial managers.

Directions powers

1.25 Directions powers enable APRA to compel a regulated entity to take specific action to address particular prudential issues that have been identified. Directions powers may also be necessary to limit further deterioration in the financial condition of a regulated entity in a period of emerging stress, and to facilitate the resolution of a distressed regulated entity.

1.26 Refining and, where appropriate, enhancing the triggers that allow the issue of directions will help ensure that APRA can respond in a more timely and decisive way to emerging prudential concerns that affect an entity. Equally, broadening the scope of the directions powers, both in respect of the matters on which directions may be given and the entities to which directions may be given, will assist APRA to respond effectively and promptly to resolve a distressed regulated entity.

1.27 It is important that an entity, its directors or other officers are able to implement a direction from APRA without potential conflicts of duties that may give rise to delay, or impede the effectiveness of the direction, particularly in a crisis. Introducing a specific immunity provision for an entity, its directors and management when complying with an APRA direction will help address this issue.

1.28 This Bill enhances the scope and efficacy of APRA's existing directions powers, including amendments to:

·
extend APRA's ability to issue directions to subsidiaries of authorised NOHCs and subsidiaries of regulated entities;
·
clarify the scope of APRA's 'catch-all' directions power;
·
clarify that APRA may issue directions requiring entities to take specified actions to facilitate resolution, whether in normal times or during a crisis;
·
clarify that APRA may give directions despite external support being in place;
·
extend APRA's ability to issue a recapitalisation direction to a regulated entity's authorised NOHC and certain other holding companies;
·
harmonise recapitalisation directions powers with general directions powers;
·
ensure that complying with an APRA direction will not be grounds for an entity, its directors or management to be held liable under any other law (subject to a good faith and reasonableness test);
·
harmonise the protection from liability provisions in the Industry Acts; and
·
provide for APRA to determine that the giving of a direction should be confidential in certain circumstances.

Transfer powers

1.29 The compulsory transfer of business powers in the Transfer Act are an important tool in APRA's crisis resolution toolkit. The Transfer Act enables some or all of the business of a regulated entity (including assets, liabilities, legal rights and obligations, data and systems) to be transferred to another regulated entity in the same category.

1.30 By international standards, the existing Transfer Act provides a comprehensive framework for compulsory transfers of business in resolution. However, there are certain areas in which the provisions could be enhanced to provide APRA with greater flexibility and certainty when arranging a compulsory transfer. For example, in some situations, rather than transferring all of the assets and liabilities comprising the business of a regulated entity, it may be more expedient to transfer ownership in the shares of the failed entity.

1.31 The Bill improves APRA's ability to implement a transfer under the Transfer Act, including amendments to:

·
enable APRA to compulsorily transfer the shares in a failing regulated entity to another body corporate;
·
widen the scope of Part 4 of the Transfer Act to apply to related entities of insurers; and
·
remove the requirement for complementary State or Territory legislation to be in place in relation to transfers of business.

Conversion and write-off of capital instruments

1.32 APRA's prudential standards require regulated entities to maintain minimum levels of regulatory capital. The prudential standards currently establish three categories of regulatory capital - Common Equity Tier 1 (CET1), Additional Tier 1 (AT1) and Tier 2 (T2) capital. AT1 and T2 capital instruments comprise securities (for example, preference shares and subordinated notes) that satisfy the eligibility criteria for AT1 and T2 capital set out in APRA's prudential standards.

1.33 APRA's prudential framework provides for two mechanisms by which AT1 and T2 capital instruments may absorb losses: conversion of those instruments into ordinary shares (or equivalent for mutually-owned ADIs), or the write-off of the instruments.

1.34 The amendments summarised below ensure that these conversion and write-off provisions operate as intended, notwithstanding any legal impediments. These proposals were developed following consultation on the Government's 2014 consultation paper 'Providing Certainty for Contractual Loss Absorption Provisions in Regulatory Capital'.

1.35 The Bill amends the Industry Acts to provide increased certainty in relation to the conversion and write-off of capital instruments, including amendments to provide that:

·
conversion or write-off can happen despite any impediment there may be in:
·
any domestic or foreign law (other than, for conversion, any laws specified in the amendments or regulations made for that purpose, including laws applying to holdings in companies under Chapter 6 of the Corporations Act or under the Financial Sector (Shareholdings) Act 1998);
·
the constitution of the entity that has issued the instrument or of an entity that is a party to the instrument and, for conversion, the constitution of the entity into whose shares the instrument converts (if different);
·
any contract or arrangement to which the issuing entity, or an entity that is a party to the instrument, is a party and (for conversion) to which the entity into whose shares the instrument converts (if different) is a party;
·
any listing rules or operating rules of a financial market in whose official list the issuing entity, an entity that is a party to the instrument, or (for conversion), the entity into whose shares the instrument converts (if different), is included;
·
any operating rules of a clearing and settlement facility through which the instrument is traded; and
·
a stay provision applies to contractual close-out rights that may arise as a result of the conversion or write-off of a capital instrument or the making of a determination by APRA that results in a requirement for the conversion or write-off of a capital instrument.

Stay provisions

1.36 An important aspect of the resolution regime is the operation of the stay provisions located in the Industry Acts and the Transfer Act. These provisions prevent counterparties of a failing entity from taking action on the grounds of APRA exercising its powers (including directions, recapitalisation directions, statutory and judicial management and transfer powers) in respect of the entity. This is important in ensuring that pre-emptive actions by counterparties do not impede the ability for APRA to implement an orderly resolution.

1.37 Given the amendments noted above to extend the scope of certain powers to group entities, the Bill enhances the stay provisions to ensure that the exercise of crisis powers by APRA does not give rise to termination or other legal rights in contracts of entities within the same relevant group of bodies corporate (a group comprising an ADI/insurer and its subsidiaries or an authorised NOHC and its subsidiaries).

1.38 A further important element of the resolution regime is the interaction of the stay provisions with the PSN Act. The PSN Act overrides a range of laws in order to ensure the validity of certain provisions relating to netting and the payments systems covered by the PSN Act. Consequential amendments are made to the PSN Act to take into account enhancements to the stay provisions, the moratorium provisions for statutory and judicial management, and the extension of certain powers to group entities. This is intended to ensure that current protections under the PSN Act are retained and the rights of counterparties to close-out netting contracts, and other arrangements covered by the PSN Act, are clear.

1.39 The Bill enhances the stay provisions, and makes consequential amendments to the PSN Act, including amendments to:

·
ensure that an exercise of a power in relation to an entity does not give rise to termination rights or other rights (that is, denying an obligation, accelerating a debt, closing-out on a transaction, or enforcing a security) in contracts of entities within the same relevant group of bodies corporate (that is, any group comprising the ADI or insurer and its subsidiaries or an authorised NOHC and its subsidiaries);
·
ensure that the current protections afforded to counterparties to certain close-out netting contracts under the PSN Act are retained (with appropriate amendments to take into account stays applying to cross-default rights); and
·
set out the relationship between the enhanced moratorium provisions for statutory and judicial management and the PSN Act, as appropriate.

Foreign branches

1.40 Foreign ADIs in Australia provide a range of important services, such as corporate lending, trade finance, wholesale lending, the provision of risk hedging to ADIs and corporate clients, and securities trading. [2]

1.41 Foreign insurers also provide important services in the Australian financial system, including providing a significant amount of reinsurance capacity to the Australian general insurance market.

1.42 While some of APRA's existing crisis powers do apply to Australian branches of foreign regulated entities (for example, APRA can apply to the Court for a judicial manager to be appointed to a foreign insurer), certain important powers, including statutory management and transfer powers, either do not apply or their application to foreign branches is currently unclear.

1.43 Given the risks that a distressed foreign regulated entity could pose to depositors or policyholders, or to financial system stability in Australia, the Bill enhances APRA's crisis management powers with respect to foreign ADIs and foreign insurers operating in Australia.

1.44 These enhancements are consistent with the Key Attributes which note that authorities should have resolution powers over local branches of foreign firms and the capacity to use the powers either to support a resolution carried out by a foreign home authority or, in exceptional cases, to take measures on its own initiative.

1.45 In a cross-border context, cooperation between relevant authorities in different jurisdictions will be important in ensuring that powers are applied in an effective and coordinated manner where necessary. Without this, it is possible that powers applied in one jurisdiction will not be recognised in other jurisdictions, leading to uncertainty for relevant stakeholders and a greater risk of disorderly outcomes. APRA will continue to develop its coordination of resolution plans with relevant authorities in other jurisdictions as part of resolution planning where relevant (see 1.58).

1.46 The Bill enhances APRA's ability to respond when a foreign branch may be in distress, including amendments to:

·
provide APRA with powers to appoint a statutory manager to the Australian branch of a foreign regulated entity;
·
clarify APRA's powers to apply to wind up the Australian branch of a foreign regulated entity;
·
harmonise the power to direct a foreign regulated entity not to transfer assets out of Australia across the Industry Acts;
·
clarify APRA's powers to implement a voluntary or compulsory transfer of business of the Australian branch of a foreign regulated entity; and
·
provide APRA with an explicit power to revoke the authorisation of a foreign regulated entity in Australia if the entity's authorisation is revoked in a foreign country.

Financial Claims Scheme

1.47 The FCS provides an important backstop within Australia's resolution regime. It protects retail depositors and policyholders by providing prompt access to their funds which, in turn, contributes to financial stability, by limiting the propensity for a destabilising 'run' on deposits in the case of ADIs, and more generally by promoting confidence in the financial system.

1.48 The FCS for ADIs provides depositors with a guarantee of their deposits up to a pre-determined cap, which is currently set at $250,000 per account-holder, per ADI. In the case of general insurers, the FCS provides compensation for most claims up to $5,000 against a failed general insurer, with claims above $5,000 also covered for eligible policyholders and certain third parties.

1.49 While the legislative framework for the FCS is broadly consistent with international standards, some of the provisions would benefit from further enhancements. Some of these enhancements were developed following consultation on the then Government's 2011 consultation paper 'Financial Claims Scheme', while others were set out in the 2012 Consultation Paper.

1.50 The Bill makes certain enhancements to the FCS framework, including amendments to:

·
establish an additional payment mechanism to enable FCS entitlements to be satisfied when there has been a transfer of deposits to another ADI or policyholder claims to another general insurer;
·
enable APRA to obtain information from third parties in relation to the FCS;
·
facilitate the effective payout of FCS entitlements to third party claimants of a policyholder of a failed general insurer where the policyholder is in liquidation;
·
enable APRA to make interim payments to claimants under the FCS applicable to general insurers;
·
grant the Treasurer the discretion to declare the FCS at an earlier time, upon appointment of a statutory manager; and
·
reduce the reporting burden regarding withholding tax in relation to interest on amounts paid under the FCS.

Wind-up and other matters

1.51 APRA's winding up powers in the Industry Acts are another important part of the crisis management toolkit, enabling it to act in situations where a regulated entity is insolvent or about to become insolvent. The ability to initiate the winding up of a regulated entity in a timely manner may assist to prevent further financial deterioration, improve outcomes for depositors and policyholders, and minimise impacts on the financial system more broadly.

1.52 While these provisions operate satisfactorily, the application of them in the past has identified areas for enhancement, and there is a lack of uniformity in APRA's powers relating to provisional liquidators and certain external administrators. The Bill therefore strengthens and simplifies APRA's powers in relation to the winding up and external administration of regulated entities under the Industry Acts.

1.53 There are also gaps and a lack of consistency between the Industry Acts in relation to APRA's ability to impose conditions on, or to revoke, an entity's authorisation. The Bill makes amendments to ensure that APRA has appropriate powers to impose conditions and revoke authorisations if certain grounds are met.

1.54 The Bill makes certain enhancements to APRA's winding up powers and powers to impose conditions on, or revoke, authorisations, including amendments to:

·
harmonise the Industry Acts with regard to APRA's involvement in external administration of regulated entities;
·
ensure that APRA's existing powers in the winding up of a regulated entity extend to where a provisional liquidator is appointed;
·
enable APRA to apply for the winding up of an ADI without the ADI having first been placed in statutory management;
·
provide APRA with notice of proposed applications for external administration of regulated entities;
·
ensure that the institution of offence proceedings is no bar to judicial management or winding up of a regulated entity;
·
enhance APRA's ability to impose, vary and revoke conditions of authorisation in certain circumstances; and
·
enable APRA to revoke authorisations on certain additional grounds under the Industry Acts.

Resolution planning

1.55 In addition to having a wide and flexible set of powers through which to intervene in a crisis, it is important APRA has clear powers to set appropriate prudential requirements for resolution planning, and to address potential barriers to the orderly resolution of a regulated entity, during normal times.

1.56 An important lesson from the global financial crisis was that effective resolution requires an advanced level of preparedness through contingency planning, before a failure or crisis event materialises. This has been reflected in the increased international focus on recovery and resolution planning, including in the Key Attributes and in BCBS and IAIS core principles.

1.57 The Bill clarifies the legislative framework for resolution planning by incorporating appropriate references within APRA's prudential standard-making powers (and matters for which regulations may be made) under the Industry Acts. It also includes amendments to clarify APRA's ability to require regulated entities and their groups to take actions to address potential barriers to orderly resolution (see 1.25 to 1.28).

1.58 In a cross-border context, resolution planning will include working with authorities in other jurisdictions to enable resolution actions to be applied in a coordinated manner where appropriate. Without this, there is a risk that APRA's resolution powers (and other related provisions in the Bill) may have reduced effectiveness on a cross-border basis or may conflict with the actions or requirements of authorities in other jurisdictions. Such coordination is consistent with APRA's current approach of working closely with supervisors in other jurisdictions where relevant.

1.59 The Bill makes amendments to strengthen the legislative framework for resolution planning, including amendments to:

·
refine and harmonise the definition of 'prudential matters' in the Industry Acts (which includes inserting a definition of this term in the Life Insurance Act for the first time);
·
clarify which entities must comply with prudential standards; and
·
enable APRA to require a holding company to ensure a regulated entity has an authorised NOHC, where appropriate.

Application and transitional provisions

1.60 The provisions of this Bill will generally apply from the date of Royal Assent. In some cases there are special application provisions which are identified where relevant.


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