Bills Digest no. 61, 2016–17                                                                                                                                                    

PDF version [716KB]

Tarek Dale
Economics Section
14 February 2017

 

Contents

Purpose and Structure of the Bill

Committee consideration

Senate Selection of Bills Committee
Senate Standing Committee for the Scrutiny of Bills

Statement of Compatibility with Human Rights

Financial implications

Policy position of non-government parties/independents

Schedule 1—Amendment of the Terrorism Insurance Act 2003

Background
Financial implications
Key issues and provisions

Schedule 2—Improving employee share schemes

Background
Employee share schemes and 2015 tax changes
Current disclosure requirements
The National Innovation and Science Agenda
Rationale for the proposed change
Policy position of non-government parties/independents
Position of major interest groups
Financial implications
Key issues and provisions
Proposed changes to disclosure requirements in Schedule 2

Schedule 3—Deductible Gift Recipient specific listings. 8

Background
Financial implications
Proposed changes to the list of deductible gift recipients
Key issues and provisions
Schedule 3—Part 1
Schedule 2—Part 2

Schedule 4—ex-gratia disaster recovery payments to special category visa (subclass 444) holders. 10

Background
Financial implications
Key issues and provisions

Schedule 5—derivative money of retail clients

Background
‘Over-the-counter’ derivatives
Client money
The response to the Financial System Inquiry
Draft legislation
Position of major interest groups
Financial implications
Key issues and provisions
Current legislation
Schedule 5, Part 1
Schedule 5, Part 2

Appendix A: recent financial collapses and regulatory responses

The collapse of MF Global
The collapse of BBY

 

Date introduced:  1 December 2016
House:  House of Representatives
Portfolio:  Treasury
Commencement: various days detailed in the body of the Bills Digest.

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the Federal Register of Legislation website.

All hyperlinks in this Bills Digest are correct as at February 2017.

 

Purpose and Structure of the Bill

The Treasury Laws Amendment (2016 Measures No. 1) Bill 2016 (the Bill) consists of five schedules:

• Schedule 1 amends the Terrorism Insurance Act 2003 to clarify that the terrorism reinsurance scheme provides insurance against chemical and biological terrorist attacks
• Schedule 2 amends the Corporations Act 2001 to reduce the public availability of information in relation to certain employee share schemes
• Schedule 3 amends the Income Tax Assessment Act 1997 (ITAA 1997) to update the list of specifically listed deductible gift recipients. It adds six entities to the list of deductible gift recipients (DGRs), ensuring that donations of $2 or more to these entities are tax deductible for the donor
• Schedule 4 amends the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 to ensure that ex‑gratia disaster relief payments made to eligible visa holders are not taxed
• Schedule 5 amends the Corporations Act to ensure that, when Australian Financial Services Licensees (AFS Licensees) receive retail client money in relation to certain derivatives, it cannot be used for other purposes.

Committee consideration

Senate Selection of Bills Committee

At its meeting of 8 February 2017, the Senate Selection of Bills Committee deferred consideration of the Bill to its next meeting.[1]

Senate Standing Committee for the Scrutiny of Bills

The Senate Standing Committee for the Scrutiny of Bills commented on two issues raised by Schedule 5 to the Bill—the authorisation of significant penalties in client money reporting rules to be made through delegated legislation and the adequacy of the consultation requirements imposed in relation to those rules.[2]

As discussed in more detail below, Schedule 5 to the Bill amends the Corporations Act to provide greater protection for retail client money and property held by AFS Licensees in relation to over-the-counter derivatives. One of the ways by which this will be achieved will be through the promulgation of client money reporting rules by the Australian Securities and Investments Commission (ASIC). Proposed section 981L of the Corporations Act, at item 14 of Schedule 5, provides that these rules may include a civil penalty of not more than $1,000,000 for breaching a rule. The Committee stated that this ‘represents a significant delegation of legislative power in that it allows rules (which are not subject to the same level of parliamentary scrutiny as primary legislation) to impose a very significant civil penalty’.[3] While noting its view that matters of such significance should usually be dealt with in primary legislation, the Committee stated that, taking into account the explanation given in the Explanatory Memorandum, it would leave the appropriateness of the proposed delegation to the consideration of the Senate as a whole.[4]

Proposed section 981L of the Corporations Act, at item 14 of Schedule 5, requires ASIC to consult the public before making the client money reporting rules. However, proposed subsection 981L(3) provides that a failure to consult does not invalidate the rules. Noting the significance of the rules to the consumer protection scheme proposed by Schedule 5 and the emphasis that the Explanatory Memorandum to the Bill places on consultation, the Scrutiny Committee has sought the Minister’s advice on the appropriateness of the ‘no invalidity clause’ in proposed subsection 981L(3).[5]

Statement of Compatibility with Human Rights

As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible.[6]

At the time of writing the Parliamentary Joint Committee on Human Rights had not considered the Bill.

Financial implications

The Explanatory Memorandum does not provide an overall estimate of the financial impact of the Bill. For Schedule 3, the Explanatory Memorandum specifies a reduction in revenue of $0.3m over 2017–18 to 2019–20 (Table 1). The other schedules are estimated to have nil or negligible financial impacts.

Table 1: financial impact of Schedule 3 ($m)

2015–16	2016–17	2017–18	2018–19	2019–20
0	0	-0.1	-0.1	-0.1

Source: Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, p. 5. 

Policy position of non-government parties/independents

The Australian Labor Party supports the bill, while noting ‘certain concerns about the way the government has approached’ Schedule 2.[7] At the time of writing other non-government parties and independents had not stated their position.

Schedule 1––Amendment of the Terrorism Insurance Act 2003

Background

Following the terrorist attacks in the USA on 11 September 2001, there was a general withdrawal of insurance cover against terrorist events. The Terrorism Insurance Scheme (‘the scheme’) was established by the Terrorism Insurance Act to replace lost coverage.[8] The scheme was initially intended as an interim measure, and the Terrorism Insurance Act requires the Minister to prepare a report reviewing the need for the continued operation of the Act at least once every three years.[9]

The most recent review (completed in December 2015) noted that the scheme had persisted into the medium term, and that there was uncertainty around the application of the legislation in relation to particular situations. Given this, it recommended:

... the application of the Act be clarified by amendments that remove doubt about whether certain losses would be covered under the scheme; in particular, losses attributable to terrorism attacks that use chemical or biological means.[10]

Position of major interest groups

The 2015 review of the Terrorism Insurance Act indicated that insurers had polarised views as to whether losses caused by chemical or biological terrorist attacks would be covered by the scheme.[11] No comments from insurers on the position proposed by the Bill have been located.

Financial implications

The Explanatory Memorandum states that the ‘amendment in Schedule 1 does not have a financial impact’.[12]

Key issues and provisions

When a terrorism incident is declared by the Minister under section 6 of the Terrorism Insurance Act then, under subsection 8(1) of that Act, ‘a terrorism exclusion in an eligible insurance contract has no effect in relation to a loss or liability to the extent to which the loss or liability is an eligible terrorism loss’.[13]

The most recent review noted that ‘doubt has arisen’ over how general exclusions in insurance contracts interact with the Terrorism Insurance Act. The review explained:

Many insurance contracts contain a range of exclusions (general exclusions) that exclude cover for losses from things like: chemical, biological and nuclear explosion, pollution or contamination; the destruction of electronic data; or the effects of micro-organisms. Doubt has arisen as to whether such exclusions constitute terrorism exclusions as defined by the Act.

This is because these exclusions do not use words like ‘terrorism’ or ‘terrorist’ or other words that specifically refer to events like terrorism, but rather merely exclude losses of a particular class of event.

If this view is correct, losses of a particular class could be effectively excluded even where they came about as the result of events declared to be terrorist incidents under the Act. Take, for example, the release of a toxic chemical agent in such circumstances that caused the event to be declared a terrorist incident under the Act. On one view, a clause that purported to exclude damages caused by the release of chemical agents, but made no mention of terrorism or like terms, would remain effective to exclude the insurer’s liability to pay claims for losses caused by the event. The uncertainty over whether general exclusions would be voided by the Act has created a lack of clarity over the coverage afforded by the terrorism insurance scheme.[14]

The review included a recommendation that:

... the application of the Act be clarified by amendments that remove doubt about whether certain losses would be covered under the scheme; in particular, losses attributable to terrorist attacks that use chemical or biological means.[15]

Schedule 1, item 1 inserts proposed paragraph 8(2)(c) into the Terrorism Insurance Act to implement that recommendation by amending the definition of terrorism exclusion to include an exclusion or exception in an insurance contract for:

... acts that are described using the word “chemical”, “biological”, “polluting”, “contaminating”, “pathogenic” or “poisoning” or words of similar effect.

Schedule 1 commences on 1 July 2017.[16] However, item 2 of Schedule 1 provides that the amended definition of terrorism exclusion applies in relation to an act or acts that are declared, at or after the commencement of the Schedule, to be a declared terrorism incident and all eligible insurance contracts in force at that time, regardless of whether those contracts were made before, at or after the commencement of the amended definition.

Schedule 2––Improving employee share schemes

Background

Employee Share Schemes and 2015 tax changes

An Employee Share Scheme (ESS) gives employees shares or options to buy shares at a discounted price, usually with eligibility for tax concessions.[17]

Current disclosure requirements

Unless an exemption is in place, ESSs are subject to disclosure requirements under Chapter 6D or Chapter 7 of the Corporations Act.[18] In particular, section 718 of the Corporations Act requires that disclosure documents for the offer of securities must be lodged with the Australian Securities and Investments Commission (ASIC) and section 719 allows for the lodgement of supplementary or replacement documents in certain circumstances.

Section 1274 of the Corporations Act specifies that subject to certain constraints, a person may inspect documents lodged with ASIC. The three most popular approaches to disclosure by companies offering an ESS are:

• preparing a compliant disclosure document
• utilising a legislative exemption to the disclosure regime under existing provisions and
• applying to ASIC for relief from reporting requirements.[19]

The National Innovation and Science Agenda

The Prime Minister, Malcolm Turnbull, and then Minister for Industry, Innovation and Science, Christopher Pyne, announced the National Innovation and Science Agenda in December 2015.[20] The National Innovation and Science Agenda (NISA) included proposed changes to Employee Share Schemes (ESS). The Government committed to:

Limit the requirement for disclosure documents given to employees under an ESS to be made available to the public [and] consult with industry on options to make ESS more user-friendly.[21]

A consultation paper on proposed changes and draft legislation were released on 26 October 2016.[22]

Rationale for the proposed change

In her second reading speech the Minister for Revenue and Financial Services, Kelly O’Dwyer, stated that disclosure requirements were ‘discouraging certain small companies and start-ups from implementing an ESS because it could result in the release of commercially sensitive information’.[23]

Policy position of non–government parties/independents

Shadow Minister for the Digital Economy Ed Husic stated that:

... the opposition is not opposed per se to those provisions of the Bill that relate to changes that will be made to the employee share scheme and some things that the government has flagged in the second reading speech ...

But I am interested to know: what has been raised, and how the Bill reflects what has been raised, in the consultation; and, importantly, how—quite separate to this—there might be situations where there is a conflict between one disclosure document regime being made private and another disclosure document regime, in terms of equity crowdfunding, being made public, and what happens in those circumstances. Again, we do not seek to oppose the Bill on this basis, but I do think it is important that some of these matters be addressed and attended to, because I think it will give a lot more certainty in the broader public space, particularly for start-ups, about what might happen to them.[24]

At the time of writing, other non-government parties and independents had not stated their position on the Schedule.

Position of major interest groups

The Treasury has not published the submissions to its consultation process. However, some stakeholders have made public comments regarding the issues addressed by the Bill.

For example, AusBiotech, an organisation representing biotechnology companies,[25] commented on the release of the National Innovation and Science Agenda:

AusBiotech is pleased to see the Government has been listening to its calls for capital gains tax breaks for investors in early stage companies, the ‘same business test’, the Biomedical Translational Fund and improvements to Employee Share Schemes.[26]

Likewise, the Employee Ownership Australia and New Zealand organisation argues on its website for a larger exemption than proposed in the draft legislation:

EOA would respectfully recommend that the current cap in s708(1) be increased to 50 investors in 12 months up to a $4 million cap. This would assist companies with employee share schemes (most SMEs have less than 50 employees and would also address the issues with capital raising through crowd sourced equity). Alternatively, the ASIC Class Order relief for unlisted is updated to have an unlimited cap (i.e. the $5,000 is removed). The Offer Document would be similar to the listed company relief with the additional requirement to include financials in the Offer Document and provide an annual update to employees. The final alternative which requires no amendment to legislation is to clarify the application of the current s708(15). The current exemption relates to offers for no consideration and could apply to free shares given to employees where equity is used as a top up because cashflow is insufficient to meet a market competitive salary. The current interpretation of this exemption is that consideration is given through the employee’s work.[27]

Financial implications

The Explanatory Memorandum states that the amendments in Schedule 2 will not have a financial impact.[28]

Key issues and provisions

Proposed changes to disclosure requirements in Schedule 2

Schedule 2, item 2 inserts proposed subparagraph 1274(2)(a)(iva) into the Corporations Act, which specifies that disclosure documents (including supplementary or replacement documents) lodged under sections 718 or 719 are not available to the general public, if the conditions set out in proposed subsection 1274(2AA) are satisfied.

Item 3 inserts proposed subsection 1274(2AA), which specifies when disclosure documents (including supplementary or replacement documents) are exempt from public inspection. The conditions include:

• the offer is under an ESS
• offering only ordinary shares, and only to staff of the company or a subsidiary
• having a turnover below $50 million in the pre-lodgement year
• that the company and others in its group were incorporated less than 10 years ago and
• ‘none of the equity interests of the issuing company or the companies in its group are listed for quotation in the official list of an approved stock exchange at the end of the issuing company’s most recent income year ...’[29]

This means that disclosure documents meeting these conditions will still be required to be lodged with ASIC, but will no longer be available to the general public.

Item 4 inserts new Part 10.28 in Chapter 10 of the Corporations Act, containing proposed section 1637, which specifies that the changes will apply to disclosure documents and replacement documents lodged with ASIC after the commencement of Schedule 2 (which will be the day after the Act receives Royal Assent).[30] The new arrangements will apply to supplementary documents lodged after commencement if the disclosure document being supplemented was also lodged after commencement.

Schedule 3—Deductible Gift Recipient specific listings

Schedule 3 to the Bill amends the ITAA 1997 to update the list of specifically-listed deductible gift recipients (DGRs).

Background

A DGR is an organisation that is entitled to receive income tax deductible gifts and deductible contributions. There are two methods of gaining DGR status:

• by applying to the Commissioner for Taxation for endorsement as a DGR or
• by having the organisation listed by name in Division 30 of the ITAA 1997 or in the Income Tax Regulations 1997.[31]

Under Division 30 of the ITAA 1997 (sections 30–1 to 30–320), taxpayers who make gifts of $2 or more to an organisation which is a DGR are able to deduct those amounts from their taxable income. Treasury estimates the annual cost to the budget of the tax deductibility for gifts to DGRs at around $1.21 billion in 2015–16.[32]

As at 31 October 2015 there were, in total, 28,146 entities listed as deductible gift recipients, including 189 specifically listed in the ITAA 1997.[33] In the 2013–14 income year individual claims for deductions were made in respect of a total of 4.5 million gifts totalling $2.6 billion.[34]

Financial implications

The Explanatory Memorandum states that Schedule 3 will reduce revenue by $0.3m between 2017–2018 to 2019–20, as per Table 2.

Table 2: financial impact of Schedule 3 ($m)

2015–16	2016–17	2017–18	2018–19	2019–20
0	0	-0.1	-0.1	-0.1

Source: Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, p. 5.

Proposed changes to the list of deductible gift recipients

Information about the activities of each of the entities is set out in the Explanatory Memorandum, and copied in Table 3 below, with links to each of the entities’ website.

Table 3: Deductible Gift Recipients (DGRs) in Schedule 3 of the Bill

Category	DGR name	Conditions	Summary of activities as outlined in the Explanatory Memorandum	Link to website
Health	Australasian College of Dermatologists	The gift must be made for education or research in medical knowledge or science.	The Australasian College of Dermatologists trains and provides continuing professional development to dermatologists and supports scientific research in the field of dermatology. It also educates and advocates to the public, government and other health care professionals about dermatological matters.	The Australasian College of Dermatologists
Health	College of Intensive Care Medicine of Australia and New Zealand	The gift must be made for education or research in medical knowledge or science.	The College of Intensive Care Medicine of Australia and New Zealand cultivates and encourages high principles of practice, ethics and professional integrity in relation to intensive care medicine practice, education, assessment, training and research. It has established fellowships and advocates on any issue which affects the ability of College members to meet their responsibilities to patients and to the community.	College of Intensive Care Medicine of Australia and New Zealand
Health	The Royal Australian and New Zealand College of Ophthalmologists	The gift must be made for education or research in medical knowledge or science.	The Royal Australian and New Zealand College of Ophthalmologists is responsible for the training and professional development of ophthalmologists in Australia and New Zealand. It leads improvements in eye health care in Australia and New Zealand through continuing professional training, education, research and advocacy. It also promotes and facilitates the improvement of eye health care internationally, particularly in developing countries, and in relation to indigenous populations.	The Royal Australian and New Zealand College of Ophthalmologists
Education	Australian Science Innovations Incorporated	The gift must be made on or after 1 January 2016.	Australian Science Innovations Incorporated (ASI) is a not-for-profit organisation whose mission is to inspire, challenge and raise the aspirations of students in science. ASI organises, fosters and promotes Australian participation in the International Biology, Chemistry, Physics and Earth Science Olympiads and related activities, as well as engaging in other activities designed to encourage science excellence in secondary education.	Australian Science Innovations Incorporated
Research	The Ethics Centre Incorporated	The gift must be made on or after 24 February 2016.	The Ethics Centre Incorporated is an independent not-for-profit organisation that has been working for over 25 years to improve lives and support communities built on strong ethical foundations. Its core objective is to relieve the significant distress faced by those struggling with complex ethical decisions and the personal and community suffering resulting from unethical behaviour.	The Ethics Centre
International Affairs	Cambridge Australia Scholarships Limited	The gift must be made on or after 1 July 2016 and before 1 July 2021.	Cambridge Australia Scholarships Limited is a not-for-profit entity established and located in Australia for the charitable purpose of advancing education by widening access to the University of Cambridge for outstanding Australian students from all backgrounds.	Cambridge Australia Scholarships

Source: Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, pp. 61–64.

Key issues and provisions

Schedule 3—Part 1

Division 30 of the ITAA 1997 sets out the rules for working out deductions for certain gifts or contributions. In particular, subdivision 30–B contains tables of recipients of deductible gifts, divided into a number of categories.

Schedule 3, items 1–4 amend the entries in various tables in Division 30 of the ITAA 1997, inserting the DGR entities outlined in the table above.

Schedule 3, items 5–10 make consequential amendments, ensuring that the DGR entities are reflected in section 30–315, which is an index to Division 30 of the ITAA 1997.

Schedule 3— Part 1 commences the day after the Act receives Royal Assent.[35] Schedule 3, item 11 specifies that the DGR status for the Australasian College of Dermatologists, the College of Intensive Care Medicine of Australia and New Zealand and the Royal Australian and New Zealand College of Ophthalmologists applies to gifts made on or after the commencement of Part 1 of Schedule 3.

Schedule 2—Part 2

The Ethics Centre Incorporated is expected to become a company limited by guarantee—The Ethics Centre Limited. Schedule 2—Part 2 changes the ITAA 1997 to reflect the change in the status of the Ethics Centre. The amendments will apply from a day set by Proclamation.[36] If the Ethics Centre does not make the change within twelve months, then the provisions are repealed.[37]

Schedule 4—ex-gratia disaster recovery payments to special category visa (subclass 444) holders

Background

The Australian Government provides support to people who are impacted by natural disasters through the income support system. While income support for impacted Australian citizens is set out in legislation, the Government also provides ex-gratia payments to New Zealand Special Category Visa (subclass 444) holders.[38] The decision to do so is made by the Prime Minister, ‘under the basis of ... authority to do so emanating from the Government’s executive powers under section 61 of the Constitution’.[39]

The Explanatory Memorandum refers to two payments: the ‘disaster recovery allowance’ or ‘income support allowance’ (the two terms are used inter-changeably in the Explanatory Memorandum), and the Disaster Recovery Payment.[40] These correspond to the legislated payments for Australians: the Disaster Recovery Allowance[41] and the Australian Government Disaster Recovery Payment.[42]

Under current law, the ex-gratia ‘disaster recovery allowance’ or ‘income support allowance’ is taxable for payments made for disasters occurring in the 2014–15 financial year and later years. The tax treatment of the ex-gratia Disaster Recovery Payment for disasters occurring in the 2014–15 financial year and future years is not explicit in the legislation.[43]

Financial implications

The Explanatory Memorandum states that the financial impact is ‘negligible’.[44]

Key issues and provisions

Schedule 4 amends tax law to ensure that the ex–gratia payments are tax free. The Minister for Revenue and Financial Services said:

Exempting disaster recovery payments from tax, or providing a rebate for income support allowances, maximises the value of the payments for people whose lives are affected by a disaster event. It also ensures that the payments are treated in the same way as disaster assistance payments made to Australians.[45]

Schedule 4 commences the day after the Act receives Royal Assent.[46]

Schedule 4, items 1–2 amend section 160AAA of the ITAA 1936 to modify the definition of a ‘rebatable benefit’ to include ‘an ex-gratia payment known as income support allowance for special category visa (subclass 444)’ in relation to specified disasters. This ensures that the recipient is eligible for a rebate of tax in relation to the payment, at the rate set out in the Income Tax Assessment (1936 Act) Regulation 2015.[47]

Schedule 4, items 3 and 5 amend the ITAA 1997 to specify that ex-gratia disaster recovery payments are exempt from income tax. Item 5 amends section 51–30 of the ITAA 1997 to include ex-gratia recovery payments in the list of welfare payments which are exempt from income tax.

Schedule 5, item 4 inserts a reference to section 160AAA of the ITAA 1936 in the list of tax offsets in section 13-1 of the ITAA 1997. This reflects the amendments in items 1–2 discussed above.

Schedule 5—derivative money of retail clients

Background

‘Over-the-counter’ derivatives

Broadly speaking, a derivative is ‘a financial instrument whose value is “derived” from an underlying asset such as a share, commodity or index’.[48]

A more technical definition in section 761D of the Corporations Act similarly centres on the fact that a derivative’s value derives from an underlying reference, such as a particular asset, rate, index or commodity price.[49] Derivatives can often be used to reduce financial risk:

A life insurance provider, for instance, may use OTC [over-the-counter] interest rate derivatives to better match the interest rate exposure of its assets and liabilities. In some cases, a firm may also use derivatives to gain a ‘synthetic’ exposure to a particular risk without transacting directly in the underlying asset, perhaps as a temporary measure to smooth investment flows. For example, a fund manager that has received an inflow of investment funds may initially use credit derivatives as an efficient and timely means of gaining a desired exposure before gradually building a position in the underlying securities.[50]

Derivatives can be centrally cleared. However, those that are not traded through a central facility are often described as ‘over-the-counter’ (OTC) derivatives.[51] OTC derivatives can offer investors greater flexibility (relative to those using standardised contracts and securities traded on ‘traditional’ exchanges) as they:

... are negotiated bilaterally between the buyer and the seller, and typically incorporate bespoke terms to allow the contracting parties either to hedge specific risks or generate tailored exposures.[52]

OTC derivatives contracts are often conducted via brokers.[53]

Client money

The Corporations Act 2001 governs how Australian Financial Services (AFS) Licensees must deal with money received from clients, including in relation to OTC derivatives.[54] Under the current regulatory framework, there is a specific exemption for client money relating to derivatives (section 981D of the Corporations Act), which reduces the level of protection by providing that such money can be used for the purpose of meeting obligations incurred by the licensee in connection with:

• margining, guaranteeing, securing, transferring, adjusting or settling dealings in derivatives by the licensee
• including such dealings on behalf of people other than the client.

As explained by ASIC, this:

allows Australian financial services licensees to withdraw client money provided in relation to retail OTC derivatives from client money trust accounts, and use it for a wide range of purposes including as working capital. This exception currently places retail derivative client money at greater risk of loss, particularly in the event the licensee becomes insolvent.[55]

Multiple failures of AFS Licensees, including notably MF Global and BBY Limited, and the potential risk of unpaid client money, have generated significant concern (see a detailed discussion in Appendix A: recent financial collapses and regulatory responses).

The Australian Government released a discussion paper on protecting client money in 2011.[56] The consultation process included a range of reform options, and issues for comment. Treasury received 105 submissions in response to the consultation.[57]

The response to the Financial System Inquiry

During the Financial System Inquiry (FSI), some submissions highlighted concerns over protection of client money.[58] However, in its final report in December 2014, the Financial System Inquiry did not explicitly discussion ‘client money’, or the need to protect client money in relation to derivatives.[59]

In its response to the FSI in October 2015, the Government announced that it would ‘develop legislative amendments to improve protections for client monies held in relation to derivatives’.[60]

Draft legislation

In December 2015 the Government released a policy paper on proposed changes to the regulatory framework, with submissions due by February 2016. Following that consultation process, the Government released draft legislation in February 2016.[61]

Position of major interest groups

The Treasury held a consultation process on changes to handling of client money in 2011; however, given the gap between the 2011 consultation process and the current legislation, this summary focuses on the stakeholder views which are available in relation to the current proposed legislation. Submissions to the 2011 paper are available from the Treasury website.[62]

In its submission on the draft legislation, the Association of Financial Advisers (AFA) stated that whilst it considered the reform as ‘a sensible regulatory correction which will bring financial advisers and other custodians of client investment money into line with other professions’ it nonetheless noted that ‘the proposed application of the amendments will disadvantage some consumers unless a reasonable transition period is allowed for client monies already held.’[63]

The Association of Securities & Derivatives Advisers of Australia Limited (ASDAA) wrote in its submission on the draft legislation that it agreed in principle with the changes (although noting areas for improvement). ASDAA’s submission stated:

ASDAA has a strong desire to raise professional standards and improve investor protection. ASDAA members rely on the ongoing trust of their clients and on the integrity of the Australian financial markets for their livelihood. Without both, clients wouldn’t participate in the markets and trade in shares, exchange traded options and other listed financial products. As a result of the failures of many large organisations within the financial services industry, like MF Global and BBY, it is clear that the current client money regime does not provide clients with the protections intended.[64]

The Australian Financial Markets Association (AFMA) stated in its submission on the draft legislation that AFMA members supported the reforms in principle, but considered that ‘far more significant’ reforms in relation to client money were needed. [65]

Whilst other stakeholders were broadly supportive of the reforms that the Bill proposes,[66] others expressed concern at the reforms and opposition to them. For example, Matt Murphie, Director of the CFD and Margin FX Association, said:

... the government is proposing to ban firms from using client money to hedge against risk, a technique applied by firms to protect a client’s portfolio and ensure client’s money remains safe.

We are extremely worried about the Federal Government’s drastic reforms because it will eliminate a large portion of industry players, not protect client money securely and will give mum and dad investors a false sense of security that the reforms have improved protection when statistics show the opposite ...

... eliminating hedging may inadvertently increase financial risk in the sector and leave customer’s vulnerable to losing money ... If the government goes ahead with this legislation, not only will consumers and firms work under a high-risk model, but business models focused on profitable clients will not be able to survive.[67]

Financial implications

The Explanatory Memorandum states that the changes to protect client money will have ‘nil’ financial impact.[68]

Key issues and provisions

Current legislation

AFS Licensees must comply with certain requirements under Divisions 2 and 3 of Part 7.8 of the Corporations Act. Subsection 981A(1) of the Corporations Act specifies the money to which Subdivision A of Division 2 applies.[69] Broadly speaking, this is money that:

• is paid in connection with a financial service or
• a financial product
• by or on behalf of the client.[70]

Under section 981B, AFS Licensees are obliged to pay the money into an account that meets particular requirements including:

• that the account is with an Australian authorised deposit-taking institution (ADI) or an account prescribed by the regulations
• that the only money paid into the account is money paid by, on behalf of, or for the benefit of, several different clients or money flowing from interest, certain investments or the proceeds of realising such investments.

Section 981C allows regulations to set out various matters in relation to an account covered by section 981B, including the circumstances in which payments may be made out of an account. However, section 981D specifies that:

Despite anything in regulations made for the purposes of section 981C, if:

(a) the financial service referred to in subparagraph 981A(1)(a)(i) is or relates to a dealing in a derivative; or

(b) the financial product referred to in subparagraph 981A(1)(a)(ii) is a derivative ...

the money concerned may also be used for the purpose of meeting obligations incurred by the licensee in connection with margining, guaranteeing, securing, transferring, adjusting or settling dealings in derivatives by the licensee (including dealings on behalf of people other than the client).[71]

Section 981D provides a very broad exemption.[72]

Schedule 5, Part 1

Schedule 5 amends the Corporations Act to restrict the exemption under section 981D, to provide greater protection for client money and property that AFS licensees receive in relation to derivatives.

Schedule 5 takes effect a year after Royal Assent.[73] However, proposed section 1636A provides that the protections enacted by the Bill will apply to all client money from the date of commencement, whether the money was received by the AFS Licensee before or after commencement.

Schedule 5, item 1 of the Bill inserts a number of new definitions into the Corporations Act. An ‘authorised clearing and settlement facility’ is defined as a licensed clearing and settlement facility in Australia, or an international clearing and settlement facility which meets certain regulatory requirements.

‘Derivative retail client money’ and ‘derivative retail client property’ are defined as money and property paid in relation to derivatives, to an AFS licensee by a retail investor.

Item 3 inserts proposed subsection 981D(2), which when read with the existing section will provide that the exemption under 981D only applies if the derivative:

• was or will be cleared through an authorised clearing and settlement facility and
• ‘under the operating rules of the facility’ the licensee incurred an obligation in connection with margining, guaranteeing, securing, transferring, adjusting or settling dealings in derivatives by the licensee (including dealings on behalf of people other than the client).

Item 4 inserts proposed subsection 984B(3), which provides similar protection in relation to client property. Item 5 inserts proposed section 1636A, specifying that proposed subsections 981D(2) and 984B(3) apply from the commencement date, including in relation to money and property received before the commencement date.

The Minister for Revenue and Financial Services said in her second reading speech:

By pursuing these reforms, we are closing a loophole, which will ensure that all retail client money is protected, in accordance with the same standards. Honourable members, the reforms I introduce today will better protect client money provided for retail derivatives by ensuring that retail client money must be held on trust for the client ...[74]

Schedule 5, Part 2

Schedule 5, Part 2 creates the ‘client money reporting rules’ regime. This will provide ASIC with greater power to monitor and enforce reporting of how client money is handled.

Item 14 inserts proposed Subdivision AA into Division 2 of Part 7.8 of the Corporations Act. Proposed Subdivision AA will provide the ASIC with the power to create ‘client money reporting rules’, which may impose reporting and reconciliation requirements, and incidental matters.

ASIC must consult before making the rules (proposed subsection 981L(1)) but failure to consult does not invalidate the rules (proposed subsection 981L(3)). As set out under ‘Committee consideration’, above, the Senate Standing Committee for the Scrutiny of Bills has sought further advice from the Minister on the appropriateness of proposed subsection 981L(3).  

Proposed section 981M provides that an AFS Licensee must comply with the client money reporting rules, with failure to do so attracting a civil penalty. The rules may prescribe a penalty of up to $1 million. Where an AFS Licensee breaches the client money reporting rules, proposed section 981N provides that regulations may provide ASIC with the power to undertake a variety of alternative enforcement procedures other than civil proceedings including requiring the person to:

• pay a penalty to the Commonwealth (but not exceeding three-fifths of the penalty amount set out in the client money rules for the rule)
• undertake or institute remedial measures (including education programs)
• accept sanctions other than the payment of a penalty to the Commonwealth or
• enter into a legally enforceable undertaking (for example, an undertaking to take specified action within a specified period, to refrain from taking specified action or to pay a specified amount within a specified period to the Commonwealth or to some other specified person).

There are a number of minor and consequential amendments included in Schedule 5, Part 2. Item 6 inserts a definition of ‘client money reporting rules’ into section 761A. Items 6–13 and 15–28 make minor technical amendments, to incorporate references to the client money reporting rules as required in other parts of the Corporations Act 2001.

Appendix A: recent financial collapses and regulatory responses

Following the global financial crisis, there was a significant international push for greater regulation of OTC derivatives. This included an international commitment by G20 leaders to improve regulation of OTC derivatives, through the Basel Committee on Banking Supervision and other international bodies.[75] This is an ongoing body of work for Australian regulators.[76]

The collapse of MF Global

MF Global Holdings Pty Ltd was an international brokerage firm that collapsed in 2011.[77] A significant aspect of the collapse was the failure of the regulatory framework to protect client funds. In December 2012 one account of the Australian situation summarised:

... clients are owed $313 million, there is $232 million in the bank, leaving more than $80 million outstanding ...[78]

The Australian Government responded in 2011 with a discussion paper on protecting client money.[79] Then Assistant Treasurer and Minister for Financial Services and Superannuation, Bill Shorten, stated:

The recent collapse of MF Global throws these issues into sharp relief. This discussion paper was being drafted before the MF Global collapse, but the Government is moving more quickly to consider these issues in light of recent events.[80]

The consultation process included a range of reform options, and issues for comment. Treasury received 105 submissions in response to the consultation.[81]

In 2012 media reported that ‘changes are on hold pending international regulatory developments and consideration of competition and compliance costs for the industry’.[82]

In December 2012 ASIC completed its report Review of Client Money Handling Practices in the Retail OTC Derivatives Sector. That report ‘identified a number of breaches of client money provisions’. ASIC was ‘concerned that many of the breaches identified were basic contraventions of well-established client money provisions’.[83]

In June 2013 a spokesperson for the Minister said:

The government is consulting with industry stakeholders and ASIC to develop options to progress regulatory reforms that will provide adequate protections for retail client monies and minimise impacts on industry.[84]

The collapse of BBY

BBY was a Sydney broking firm which collapsed and was put into administration in May 2015.[85] A December 2015 report by KPMG found a number of transactions between client accounts, and BBY ‘house’ accounts:

We identified many instances in which funds were transferred between various CSAs [client segregated accounts] and between CSAs and BBYL ‘house’ accounts, many of which appear to have occurred in the ordinary course of business or which were ultimately ‘made right’ by way of return of funds. We also identified ‘transactions of interest’ which we consider to be outside of the ordinary course of business and may have led to the depletion of CSAs and shortfalls against client obligations.[86]

That report also found ‘an overall shortfall in client monies ... of $17.0 million.’[87] Subsequent media reporting suggests a shortfall $23 million in the $40 million of outstanding debts to creditors.[88]

 

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[1].         Senate Selection of Bills Committee, Report, 1 2017, The Senate, Canberra, 9 February 2017, p. 4.

[2].         Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 1, 2017, The Senate Canberra, 8 February 2017, pp. 42–44.

[3].         Ibid., p. 43.

[4].         Ibid.

[5].         Ibid., p. 44.

[6].         The Statements of Compatibility with Human Rights in relation to the various schedules can be found at pages 43, 59–60, 64, 69 and 134–135 of the Explanatory Memorandum to the Bill.

[7].         A Leigh, ‘Second reading speech: Treasury Laws Amendment Bill (2016 Measures No. 1) Bill 2016’, House of Representatives, Debates, 7 February 2017, pp. 73–74.

[8].         Treasury, Terrorism Insurance Act—review: 2015, Canberra, 2015, p. 5.

[9].         Ibid., p. 1 and section 41 of the Terrorism Insurance Act 2003.

[10].      Ibid., p. 3.

[11].      Treasury, Terrorism Insurance Act—review: 2015, op. cit., pp. 28 and 82.

[12].      Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, p. 3.

[13].      Terrorism Insurance Act 2003, subsection 8(1). ‘Eligible terrorism loss’ is defined in section 3 as a loss or liability arising from a declared terrorist incident.

[14].      Treasury, Terrorism Insurance Act—review: 2015, op. cit., pp. 28 and 82.

[15].      Ibid.

[16].      Clause 2, table item 2.

[17].      Australian Taxation Office (ATO), ‘Employee share schemes’, ATO website, 21 December 2015. For a more detailed discussion of employee share schemes, see L Nielson and J Murphy, Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015, Bills digest, 92, 2014–15, Parliamentary Library, Canberra, 6 May 2015, pp. 3–4.

[18].      Australian Government, National Innovation and Science Agenda—employee share schemes, Consultation paper, 26 October 2016, p. 2.

[19].      Ibid., p. 2; Australian Securities and Investments Commission (ASIC), Employee incentive schemes, Regulatory guide, 49, November 2015.

[20].      M Turnbull (Prime Minister) and C Pyne (Minister for Industry, Innovation and Science), National Innovation and Science Agenda, media release, 7 December 2015.

[21].      National Innovation and Science Agenda (NISA), ‘Attracting talent through reforms to Employee Share Schemes’, NISA website.

[22].      Treasury, ‘Treasury Laws Amendment (Enterprise Incentives) Bill 2016: improving employee share schemes’, Treasury website, 26 October 2016; Treasury, ‘National Innovation and Science Agenda—employee share schemes’, Treasury website, 26 October 2016.

[23].      K O’Dwyer (Minister for Revenue and Financial Services), ‘Second reading speech: Treasury Laws Amendment (2016 Measures No. 1) Bill 2016’, House of Representatives, Debates, 1 December 2016, p. 5129.

[24].      E Husic, ‘Second reading speech: Treasury Laws Amendment (2016 Measures No. 1) Bill 2016’, House of Representatives, Debates, 7 February 2016, pp. 75­76. The other legislation referred to by Mr Husic is: Parliament of Australia, ‘Corporations Amendment (Crowd-sourced Funding) Bill 2016 homepage’, Australian Parliament website.

[25].      AusBiotech, ‘About AusBiotech’, AusBiotech website, 3 November 2016.

[26].      AusBiotech, AusBiotech welcomes innovation’s new place firmly on Australia’s agenda, media release, 8 December 2015.

[27].      Employee Ownership Australia and New Zealand, ‘Improving employee share schemes—time for a rethink’, Employee Ownership Australia and New Zealand, website, 10 November 2016.

[28].      Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, p. 4.

[29].      Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, p. 46.

[30].      Clause 2, table item 3.

[31].      Income Tax Assessment Act 1997, sections 30–17 and 30–120.

[32].      Treasury, Tax expenditures statement 2015, Canberra, January 2016, p. 8.

[33].      Australian Taxation Office (ATO), Taxation Statistics 2014–15, ‘Charities—Table 3: Deductible Gift Recipients, by type, for the 2013–14 income year’.

[34].      ATO, Taxation Statistics 2013–14, Charities—Table 5: Individual gifts claims, for the 2013–14 financial year.

[35].      Clause 2, table item 4.

[36].      Clause 2, table item 5.

[37].      Ibid.

[38].      K O’Dwyer (Minister for Revenue and Financial Services), ‘Second reading speech: Treasury Laws Amendment (2016 Measures No. 1) Bill 2016’, op. cit.; for a discussion of the legislative framework for disaster relief payments to Australian citizens, see M Klapdor, Social Security Legislation Amendment (Disaster Recovery Allowance) Bill 2013, Bills digest, 107, 2012–13, Parliamentary Library, Canberra, 13 May 2013.

[39].      M Klapdor, Social Security Legislation Amendment (Disaster Recovery Allowance) Bill 2013, op. cit., p. 6.

[40].      Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, pp. 65–66.

[41].      Department of Social Services (DSS), ‘1.2.6.40 Disaster Recovery Allowance (DRA)—description’, Guide to social security law, version 1.227, DSS website, 17 August 2015.

[42].      DSS, ‘1.2.6.20 Australian Government Disaster Recovery Payment (AGDRP)—description’, Guide to social security law, version 1.227, DSS website, 2 January 2015.

[43].      Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, p. 67.

[44].      Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, p. 5.

[45].      K O’Dwyer (Minister for Revenue and Financial Services), ‘Second reading speech: Treasury Laws Amendment (2016 Measures No. 1) Bill 2016’, op. cit.

[46].      Clause 2, table item 6.

[47].      Income Tax Assessment (1936) Act Regulations 2015.

[48].      Australian Securities and Investments Commission (ASIC), ‘Glossary—derivative’, Moneysmart website, 23 August 2011.

[49].      Corporations Act 2001, section 761D.

[50].      A Clarke and P Ryan, ‘Non-dealer clearing of over-the-counter derivatives’, Reserve Bank Bulletin, March 2014, p. 77.

[51].      Australian Securities and Investments Commission (ASIC), ‘OTC derivatives reform—frequently asked questions’, ASIC website, 22 November 2016; A Velonis, ‘Protecting client collateral in the Australian OTC derivatives market: an examination of the relationship between central clearing, account structures and the client money provisions’, Insolvency Law Journal, 21, 2013, p. 179.

[52].      Australian Prudential Regulation Authority (APRA), Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA), Survey of the OTC derivatives market in Australia, May 2009, p. 4.

[53].      Ibid., p. 13.

[54].      Treasury, Enhanced protection of client money, Policy paper, 21 December 2015, p. 1.

[55].      Australian Securities and Investments Commission (ASIC), ASIC welcomes ‘client money’ reforms, media release, 16-378, 8 November 2016.

[56].      Treasury, Handling and use of client money in relation to over-the-counter derivatives transactions, Discussion paper, November 2011.

[57].      Treasury, ‘Submissions: handling of client money in relation to OTC derivatives transactions’, Treasury website.

[58].      Macquarie Group Limited, Submission to Treasury, Financial system inquiry, 31 March 2014, pp. 9–10; Chi-X Australia, Submission to Treasury, Financial system inquiry, 31 March 2014, p. 6.

[59].      Treasury, Financial system inquiry, Final report, (Murray Report), Canberra, November 2014.

[60].      Australian Government, Improving Australia’s financial system: Government response to the Financial System Inquiry, 2015, p. 26.

[61].      Treasury, ‘Client money reforms’, Treasury website, 29 February 2016.

[62].      Treasury, ‘Handling and use of client money in relation to over-the-counter derivatives transactions’, Treasury website, 19 November 2011.

[63].      Association of Financial Advisers (AFA), Submission to Treasury, Client money reforms, 23 March 2016, pp. 1–2.

[64].      Association of Securities and Derivatives Advisers of Australia Limited, Submission to Treasury, Client money reforms, 24 March 2016, p. 1.

[65].      Australian Financial Markets Association, Submission to Treasury, Enhanced protection of client money—exposure draft Corporation Amendment (Client Money) Bill 2016, Regulation and Explanatory Memorandum, 29 March 2016.

[66].      T Szabo, ‘Why firms shouldn’t be allowed to trade with clients’ money’, The Australian, 28 November 2016, p. 27; D Rogers and A White, ‘Protection for client funds in the derivative industry’, The Australian, 9 November 2016, p. 28.

[67].      A Saks-McLeod, ‘Australia’s Director of CFD & Margin FX Association speaks out against anti-hedging proposals’, FinanceFeeds website, 14 January 2016.

[68].      Explanatory Memorandum, Treasury Laws Amendment (2016 Measures No. 1) Bill 2016, p. 6.

[69].      Subdivision A of Division 2 of Part 7.8 of the Corporations Act consists of sections 981A to 981H.

[70].      Corporations Act 2001, subsection 981A(1).

[71].      Corporations Act 2001, section 981D.

[72].      Treasury, Handling and use of client money in relation to over-the-counter derivatives transactions, Discussion paper, November 2011, p. 5.

[73].      Clause 2, table item 7.

[74].      K O’Dwyer (Minister for Revenue and Financial Services), ‘Second reading speech: Treasury Laws Amendment (2016 Measures No. 1) Bill 2016’, op. cit.

[75].      O Harvey (Senior Executive Leader, ASIC), Looking beyond the margins of OTC derivatives reform, Keynote address: 2016 ISDA Annual Australia Conference, 20 October 2016, p. 3.

[76].      APRA, ASIC and the RBA, Report on the Australian OTC Derivatives Market, November 2015; O Harvey, Looking beyond the margins of OTC derivatives reform, op. cit.

[77].      T Boyd, ‘Chanticleer: MF Global collapse’, The Australian Financial Review, 15 November 2011, p. 64.

[78].      A Ferguson, ‘$34m investor funds in limbo’, The Age, 19 December 2011, pp. 1–2.

[79].      Treasury, Handling and use of client money in relation to over-the-counter derivatives transactions, op. cit.

[80].      B Shorten (Assistant Treasurer), Protecting client money in over-the-counter derivatives, media release, 19 November 2011.

[81].      Treasury, ‘Submissions: handling of client money in relation to OTC derivatives transactions’, Treasury website.

[82].      J Kehoe, ‘Client money at risk as Shorten studies options’, The Australian Financial Review, 3 September 2012, p. 15.

[83].      ASIC, Review of client money handling practices in the retail OTC derivatives sector, Report 316, December 2012, p. 5.

[84].      M Ruehl, ‘Self regulation not working, says forum’, The Australian Financial Review, 5 June 2013, p. 19.

[85].      M Han and J Moullakis, ‘Blame game follows BBY’s fall’, The Australian Financial Review, 24 September 2016, p. 17; T Sykes, ‘Inside the collapse of BBY’, The Australian Financial Review, (online edition), 15 March 2016; J Moullakis and M Han, ‘The downfall of BBY that took the Rosewalls with it’, The Australian Financial Review, (online edition), 24 September 2016.

[86].      KPMG, Client monies investigations—liquidators’ report: BBY Limited, 22 December 2015, p.12.

[87].      Ibid., p. 109.

[88].      M Han and J Moullakis, ‘Blame game follows BBY’s fall’, The Australian Financial Review, op. cit., p. 6.

 

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