An extract from The International Capital Markets Review, 11th Edition

Introduction

Australia has vibrant, professional and well-regulated capital markets open to foreign issuers.2

The recent 'Why Australia: Benchmark Report 2021' from the Australian Trade Commission indicates that Australia's capital markets comprise, inter alia:

  1. the third-largest stock market, by market capitalisation of freely floating stocks, in the Asian region and the ninth-largest globally;
  2. the third-largest debt capital market in the Asian region; and
  3. the fifth-largest superannuation (retirement savings) industry in the world.3
i Structure and regulation

Australia is a federation with three different levels of government: commonwealth (or federal), state and territory, and local (or municipal). As a general rule, commonwealth legislation governs access to, and the operation and supervision of, Australia's capital markets. Under the Constitution, the commonwealth has power to legislate in relation to, among other matters, corporations, interstate and international trade and commerce, taxation, banking and insurance. Australia has an independent judicial system that reflects the constitutional division of powers between the commonwealth government and the state and territory governments.

The broad framework for the regulation of the financial sector, including capital markets, is determined by the commonwealth government. The issuance and trading of debt and equity securities, derivatives, securitisation and other financial products are primarily governed by Chapters 6D and 7 of the Corporations Act 2001 of Australia (Corporations Act) (which applies throughout the country), as well as by the common law and principles of equity.4

Under the Corporations Act, the term financial product is defined in general terms and there are specific inclusions and exclusions. Broadly, a financial product is any facility through which a person makes a financial investment, manages financial risk or makes non-cash payments, even if the facility is used for some other purpose. The specific inclusions illustrate the wide scope of the concept and include equity and debt securities, interests in managed investment schemes (i.e., unit trusts and other collective investments), derivatives, foreign exchange contracts, most insurance contracts, most superannuation (retirement savings) products, most deposit-taking facilities provided by Australian banks and other authorised deposit-taking institutions (ADIs), and government debenture and bond issues. The specific exclusions are generally products that are more suitably regulated under some other regime (such as credit facilities and payment systems).

Australia's framework for the regulation of the financial sector and the issuance of financial products is based on three separate agencies operating on functional lines. These regulatory bodies have primary responsibility for maintaining the safety and soundness of markets and regulated institutions, protecting consumers and promoting systemic stability through implementing and administering the applicable regulatory regimes. Specifically:

  1. the Australian Securities and Investments Commission (ASIC) is the corporate, markets and financial services regulator responsible for market conduct and investor protection;
  2. the Australian Prudential Regulation Authority (APRA) is responsible for the prudential regulation and supervision of banks and other ADIs, life and general insurance companies and most participants in the superannuation industry; and
  3. the Reserve Bank of Australia (RBA) is responsible for monetary policy, overseeing financial system stability and the payments system.

The Council of Financial Regulators (CFR) is the coordinating body for Australia's main financial regulatory agencies. It is a non-statutory body whose role is to contribute to the efficiency and effectiveness of financial regulation, to promote the stability of the Australian financial system and to advise the commonwealth government on the adequacy of Australia's financial regulatory arrangements. Its membership comprises the RBA (which chairs the CFR), APRA, ASIC and the Commonwealth Treasury.

In addition, the Australian Competition and Consumer Commission (ACCC) is responsible for competition policy, with a mandate that extends across the entire economy, including the financial services sector.

The vibrancy of Australia's capital markets is underpinned by:

  1. a history, since the mid 1980s, of legislative reform promoting growth and investment;
  2. an increasing demand by investors for a wide range of financial products (because of, in part, increased savings as a result of Australia's compulsory superannuation system);
  3. a highly educated, skilled, multilingual and computer-literate labour market, particularly in the financial sector;
  4. a strategic location in the Asia-Pacific region; and
  5. increasing integration with global capital markets.

Until recently, there has been a low level of issuance of government and semi-government fixed interest securities due to budget surpluses. This has changed dramatically as a result of measures to address the covid-19 pandemic.

In addition to participating in the domestic capital markets, the commonwealth, state and territory governments, semi-government authorities and companies have regularly issued securities and other financial products in international capital markets and the domestic capital markets of a number of foreign countries (most commonly, the United Kingdom, the United States and Japan).

ii Prudential regulation and supervision

APRA's core objective is 'the financial safety of institutions and the stability of the Australian financial system', together with the supplementary considerations of efficiency, competition, contestability and competitive neutrality.5 The framework for prudential regulation includes requirements regarding capital adequacy, credit risk, market risk, covered bonds, securitisation, liquidity, credit quality, large exposures, associations with related entities, outsourcing, business continuity management, audit and related matters, governance, and fit and proper management.6

In the prudential standards for ADIs, APRA formally introduced the Basel III definition of regulatory capital, the minimum requirements for the different tiers of capital and stricter eligibility criteria for capital instruments with effect from 1 January 2013. In some instances, similar requirements have been introduced for life and general insurance companies.

There are three main elements in APRA's approach to the Basel III capital reforms, as follows:

  1. the Basel III definition of regulatory capital, the Basel III minimum requirements and eligibility criteria for regulatory capital instruments, and the Basel III regulatory adjustments to capital each specify minimum requirements, with only minor exceptions;
  2. for in-principle reasons, APRA did not adopt the concessional treatment available for certain items in calculating regulatory capital, a discretion that was available under the Basel III reforms. These items are deferred tax assets relating to temporary (timing) differences, significant investments in the common shares of non-consolidated financial institutions and mortgage servicing rights. APRA has never recognised these items in calculating regulatory capital and, in APRA's view, to do so would not be consistent with the objective of raising the quality and quantity of regulatory capital in Australia; and
  3. APRA has adopted an accelerated Basel III timetable in some areas.

The chair of APRA has commented that APRA's approach to the Basel III capital reforms 'reflects its firmly held view that conservatism has served Australia well before and during the crisis, that the milestones are not demanding, and that the impact of higher capital requirements on the overall funding costs of ADIs is likely to be small'.7

On 1 January 2015, a liquidity coverage ratio (LCR) regime commenced, consistent with the Basel III liquidity framework. ADIs subject to the LCR8 must at all times be able to demonstrate their ability to withstand a minimum of 30 days of severe liquidity stress. ADIs subject to the LCR are able to apply for a committed liquidity facility (CLF) made available by the RBA. The CLF is sufficient in size to cover any shortfall between ADIs' holdings of high-quality liquid assets (presently limited to commonwealth and state government securities) and the requirement to hold such assets under the LCR. As issues of government debt increase, it is expected that the CLF will decline.9 In September 2021, APRA announced that it expected ADIs to reduce their usage of the CLF to zero by the end of 2022, subject to market conditions.10

Capital conservation and countercyclical buffers for ADIs were introduced on 1 January 2016. ADIs are now required to meet a minimum common equity capital requirement of 7 per cent of risk-weighted assets, including the capital conservation buffer. Dividends and other discretionary payments will be constrained if levels of common equity capital fall below that percentage. The countercyclical buffer will be deployed by APRA in periods when excess aggregate credit growth is adjudged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses. As at December 2019, the countercyclical buffer has remained unchanged at zero per cent since its introduction.11 However, it may be varied over time between zero and 2.5 per cent depending on market conditions.

APRA has also developed a framework for dealing with domestic systemically important banks, which came into effect on 1 January 2016. Its work on capital strength, liquidity management, securitisation, resolution planning, conglomerate groups and shadow banking is ongoing.

iii Access, authorisation and licensing

An Australian entity is not required to obtain any general government authorisations or consents prior to issuing securities in Australia. In most cases, the only authorisations and consents required are those prescribed by the issuer's constitutional documents or governing statute.

Foreign companies are also not subject to any direct government controls in issuing securities in Australia12 and, since April 1991, foreign governments, their agencies and international organisations have also been permitted to raise funds in the Australian domestic debt capital markets, subject to some limited restrictions (e.g., the debt securities must be in registered, not bearer, form). However, the issuance of other types of financial products, and the trading of both securities and other financial products, may require the issuer or trader to hold an Australian financial services licence (AFSL) from ASIC under Chapter 7 of the Corporations Act (or be exempt from the requirement to do so).

A person who carries on a financial services business in Australia (including a person who engages in conduct that is intended, or likely, to induce people in Australia to use his or her financial services)13 is required to hold an AFSL (or be exempt from the requirement to do so). A person provides a financial service if he or she engages in certain activities, in particular:

  1. providing financial product advice;
  2. issuing or otherwise dealing in a financial product;
  3. making a market for a financial product;
  4. operating a registered managed investment scheme; or
  5. providing a custodial or depository service (i.e., holding financial products on behalf of others).14

Although numerous exemptions are available for particular financial services or financial products (e.g., an entity issuing its own securities, or the acquisition and disposal of a financial product if a party is dealing on its own behalf provided that it is not the issuer of that financial product),15 there are few exemptions of general application. Certain regulated foreign financial institutions that operate in foreign jurisdictions that have a level of investor protection similar to Australia's can apply for a modified form of AFSL licence, known as a 'foreign AFS licence', authorising them to provide financial services to wholesale clients or professional investors in Australia.16 Transitional arrangements will apply to foreign financial service providers (FFSP) that were able to rely on the now repealed relief for foreign financial institutions operating in foreign jurisdictions that have a level of investor protection similar to Australia's. These transitional arrangements will continue to apply to FFSPs from 1 April 2020 until either the FFSPs have been granted a foreign AFS licence commencing before 31 March 2023 or the transitional period has ended on 31 March 2023 (whichever occurs first).17

There is no requirement that financial products issued in Australia be governed by Australian law, although investors are generally more familiar with Australian law, and there may be investment restrictions precluding a particular investor from purchasing financial products governed by foreign law. In certain cases, there is an expectation that financial products will be governed by Australian law – for example, issues of many financial products to retail clients (see below) and the issue of debt securities in the kangaroo bond market.18

Securities issued by Australian financial institutions that are intended to qualify as regulatory capital are required to have provisions relevant to loss absorption governed by Australian law.19

A person who undertakes the business of providing financial product advice (e.g., recommending the purchase of securities) requires a licence.20 Since 1 July 2013, advisers have been subject to a duty for financial advisers to act in the best interests of their clients (subject to a reasonable steps qualification) and place the best interests of their clients ahead of their own when providing personal advice to retail clients; and a ban on conflicted remuneration structures (including commissions and volume-based payments) in relation to the distribution of, and advice about, a range of retail investment products.21

An institution that wishes to conduct banking business must be granted an ADI licence by APRA prior to conducting business as an ADI. As at 31 March 2021, there were 146 ADIs operating in Australia.22 Australian ADIs are major issuers in the domestic and international capital markets, with APRA's June 2021 statistics showing approximately A$812 billion in combined total short-term and long-term borrowings for selected ADIs.23 In May 2018, APRA announced a new restricted ADI framework. The framework allows eligible entities to seek a restricted ADI licence to conduct a limited range of business activities for two years while they build their capabilities. It establishes the eligibility criteria, minimum initial and continuing requirements, and the application of the prudential and reporting standards during the restricted phase of operation.24 APRA published updated guidelines on the Restricted ADI licensing framework in August 2021.25

APRA has previously clarified its policy expectations with respect to business conducted in Australia, or with Australian customers, by foreign banks that are not authorised to carry on banking business in Australia as a foreign ADI (i.e., through a local branch).26 APRA generally takes the position that foreign banks soliciting and operating an active business in Australia should be subject to Australian prudential regulation and supervision, regardless of where the business is booked. However, APRA does not object to a foreign bank conducting limited business with Australian counterparties from its offshore offices, provided certain conditions are satisfied. While APRA expects that a foreign bank licensed as a foreign ADI in Australia will book its Australian business in the Australian branch, it should be noted that foreign ADIs are not restricted to issuing bonds into the Australia market from their Australian branch; such bonds may be issued from their head office. Recently, there have been Canadian, Korean, US and Singaporean banks that have issued bonds into the Australia market from their head office rather than through an Australian branch.

In March 2018, the Treasury Laws Amendment (Banking Measures No. 1) Act 2018 came into effect to further regulate non-ADI lenders, including non-ADI mortgage originators.27 This law extended APRA's powers to allow APRA to make rules and issue directions relating to the lending activities of non-ADI lenders where it has identified material risks of instability in the Australian financial system. Directions, powers and penalties were also introduced for non-ADI lenders who contravene a direction from APRA. This gave APRA further control over entities that provide finance in Australia but that are not considered to be conducting banking business under the Banking Act 1959 as they do not take deposits. However, these powers do not extend to the continuing prudential regulation and supervision of non-ADI lenders that APRA currently has over ADIs. This law also requires certain non-ADI lenders to register under the Financial Sector (Collection of Data) Act 2001 to allow APRA to gain access to their lending data.

iv Offers of securities and other financial products

Offers for the issue and (in certain cases) the sale or purchase of equity and debt securities28 in Australia are regulated by Part 6D.2 of the Corporations Act, whereas the issue of other financial products is regulated by Part 7.9 of the Corporations Act. The provisions of the Corporations Act relating to offers of securities, and other financial products for issue or sale, do not apply to offers received outside Australia.29

As a general matter, a person must not offer or invite applications for the issue, sale or purchase of securities in Australia (including an offer or invitation that is received by a person in Australia) unless a prospectus or other disclosure document that complies with the form and content requirements of the Corporations Act has been lodged with ASIC. A similar requirement in relation to the lodgement with ASIC of a product disclosure statement (PDS) is set out in Part 7.9 of the Corporations Act in relation to offers for the issue and (in certain cases) the sale or purchase of other financial products.

The basic regulatory approach is based on disclosure. There is no general requirement for a prospectus, PDS or other disclosure document to be vetted or reviewed by ASIC or any other regulator before lodgement and publication. However, ASIC has signalled that there should be a shift away from overreliance on disclosure for consumer protection with the introduction of design and distribution obligations (DDO) and ASIC's product intervention powers to target consumer detriment for financial and credit products.30

At a high level, a prospectus or other disclosure document in relation to securities must contain all information that investors and their professional advisers would reasonably require to make an informed assessment of specific matters, including the rights and liabilities attaching to the securities offered, and the assets and liabilities, financial position and performance, profits and losses, and prospects of the issuer.31

The information must be presented in a clear, concise and effective manner. Similar requirements apply to a PDS or other disclosure document in relation to other financial products, although the precise content requirements vary depending on the financial product. ASIC has published regulatory guidance concerning the main disclosure requirements of Chapter 6D of the Corporations Act, including:

  1. how to word and present a prospectus in a clear, concise and effective manner, including guidance on communication tools and the use of an investment overview to highlight key information;
  2. the content required to satisfy the general disclosure test of the Corporations Act, as well as guidance on business models, risks, financial information and management; and
  3. the specific disclosure required by the Corporations Act, including details of the offer and the interests of persons involved in the offer.32
Simple corporate bonds

The Corporations Amendment (Simple Corporate Bonds and Other Measures) Act 2014 significantly changed the legal processes, documentation and liability for simple corporate bonds offered by an Australian listed company to retail investors. This Act was a welcomed development to assist the development of the retail corporate bond market in Australia.33

Essentially, the legislation removed an anomaly in the previous law that required a full prospectus, satisfying equity disclosure standards, for a retail offer of simple corporate bonds by a listed company. Previously, an Australian listed company could issue additional equity to its shareholders with an investor presentation and a 'cleansing statement' released on the Australian Securities Exchange (ASX) or could raise debt from the wholesale market with a simple offering memorandum and term sheet. Accordingly, the reform aimed to reduce the disparity between requirements for retail debt offers, retail rights issues of additional equity and wholesale debt offers. The key changes are as follows:

  1. defining the debt securities that qualify as simple corporate bonds;34
  2. the introduction of a streamlined two-part disclosure regime for offers of simple corporate bonds (a base prospectus with a life of up to three years and a short form offer specific prospectus). The content requirements for a prospectus for a simple corporate bond are set out in regulations;35
  3. the removal of deemed civil liability for a director of a company making an offer under the prospectus (underwriters and others named in a prospectus, and anyone involved in a contravention, remain subject to the deemed liability); and
  4. changes to the criminal liability for misleading and deceptive statements in relation to a prospectus.

The first issue of a simple corporate bond took place in November 2015, by Australian Unity, and the second in June 2016, by Peet Limited. In April 2017, Villa World Limited became the third company to offer a listed simple corporate bond in Australia. In June 2017, Peet Limited issued another round of simple corporate bonds. In July 2018, Axsesstoday Ltd became the fourth company to successfully launch a simple corporate bond offer in Australia. However, the company was subsequently placed into administration in April 2019. Australian Unity also launched a further offer of simple corporate bonds in September 2019.

There remain many other commercial and market forces that need to align for the Australian domestic retail corporate bond market to develop significantly. These include the linking of the retail and corporate trading platforms, the comparative costs of accessing the wholesale and retail markets and further education for investors about this asset class.

Exempt wholesale offers

The requirement to issue a prospectus or other disclosure document for an offer of securities does not apply where the relevant securities are issued for a consideration of at least A$500,000 per offeree (disregarding amounts lent by the offeror and its associates). In addition, a prospectus or other disclosure document is not required if potential subscribers and buyers are restricted to professional investors (as defined in the Corporations Act)36 or the requirements of another exemption are satisfied,37 allowing an issue for a lesser consideration to occur without disclosure in accordance with the Corporations Act. Similar restrictions can apply to the offering of securities for sale or purchase in the secondary market in certain cases.

Regarding other financial products, similar (but subtly different) exemptions apply: the requirement to issue a PDS or other disclosure document only applies to an offer to a retail client (defined as a person who is not a wholesale client). In summary, a person is a wholesale client if at least one of the following four tests applies (all other persons are retail clients):

  1. the consideration payable for the product is at least A$500,000;
  2. the product is provided in connection with a business that is not a small business (this normally means at least 20 employees);
  3. the client's net assets are at least A$2.5 million or income for each of the past two years is at least A$250,000; or
  4. the client is a professional investor.

The vast majority of offers of debt securities and other financial products by foreign issuers or offerors are structured so as not to require the issue of a prospectus, PDS or other disclosure document in compliance with the form and content requirements of either Part 6D.2 or 7.9 of the Corporations Act. It is important to note that a foreign company that offers debentures in Australia or guarantees debentures offered in Australia will be deemed to carry on business in Australia for the purposes of the Corporations Act, unless the offer is structured so as not to require the issue of a prospectus.38

Liability issues

A person must not offer securities or other financial products under a prospectus, PDS or other disclosure document that is misleading or deceptive or omits material required to be included by either Part 6D.2 or 7.9 of the Corporations Act. Those who may be liable include the issuer, directors of the issuer, other persons named in the disclosure document and persons otherwise involved in the contravention of the disclosure requirements. There is a range of defences to liability for a disclosure document; these are broadly based on the concepts of reasonable enquiry and reasonable reliance (i.e., due diligence defences).39

Irrespective of whether the offering of securities or other financial products requires disclosure to investors in accordance with either Part 6D.2 or 7.9 of the Corporations Act, an issuer or offeror may incur liability under various provisions that prohibit:

  1. offering financial products under a document that contains a misleading or deceptive statement or a statement likely to mislead or deceive;
  2. creating an artificial price for trading in financial products on a financial market operated in Australia;
  3. creating a false or misleading appearance about the market or price for financial products;
  4. spreading misleading or false information;
  5. otherwise engaging in misleading or deceptive conduct or conduct that is likely to mislead or deceive (including by omission and, in certain circumstances, by remaining silent); or
  6. conduct that is unconscionable.40

In general terms, these prohibitions are unlikely to impose any greater restrictions on an issuer or offeror than would be encountered in many segments of the international capital markets.

Debentures and embedded derivatives

As noted above, offers for the issue of debt securities (i.e., debentures) in Australia are regulated by Part 6D.2 of the Corporations Act, whereas the issue of derivatives is regulated by Part 7.9 of the Corporations Act. Where structured notes are offered, in light of two decisions of the Federal Court of Australia, consideration needs to be given as to whether the note is properly classified as a debenture or a derivative, as this may affect who is licensed to distribute or invest in the note and other duties in respect of the offer.

In the first decision,41 the Court found that certain complex collateralised debt obligations were properly characterised as 'undertaking[s] by the [issuer] to repay as a debt money deposited with or lent to the [issuer]' (i.e., they could have been debentures (although they were not in the particular facts of the case)). In the second decision,42 the Court found that certain constant proportion debt obligations (CPDOs) in the form of notes were derivatives. It is difficult to reconcile aspects of the reasoning applied in the two decisions.

Liability of rating agencies

The second Federal Court decision mentioned above is also notable for the finding that Standard and Poor's (S&P) was liable for misleading and deceptive conduct and negligence, by assigning an AAA rating to the CPDOs. The Court held that the rating conveyed the representation that S&P had reached this opinion based on reasonable grounds and as a result of an exercise of reasonable care. In this case, the representation was misleading and there was a breach of the duty to take reasonable care.

v Some other features of Australia's capital markets43Exchanges

The ASX was created through the merger of the Australian Stock Exchange and the Sydney Futures Exchange and is operated by ASX Limited. Previously, the ASX was in charge of supervising and enforcing all market and trading rules in respect of its markets. However, ASIC has now assumed the supervision of trading activities by market participants.

All listed entities must prepare and lodge an annual audited financial report and an audited or audit-reviewed half-year financial report, complying with Australian accounting standards (which are based on International Financial Reporting Standards). Listed entities must also describe their corporate governance practices in detail in their annual reports. In addition, listed entities and the responsible entities of listed managed investment schemes must comply with the continuous disclosure requirements of the Corporations Act and the ASX Listing Rules,44 and must immediately disclose (via announcements made to the ASX) any information concerning itself that a reasonable person would expect to have a material effect on the price or value of its securities.45

Chi-X Australia Pty Ltd (Chi-X) has, since November 2011, operated as an alternative securities exchange, boosting competition in Australia's financial markets.46 Chi-X has ASIC approval to trade in all S&P/ASX 200 component stocks and ASX-listed exchange traded funds. However, it operates only as an execution forum through which securities quoted on the ASX can be traded.

Since 1994, the ASX has operated the Clearing House Electronic Subregister System (CHESS), a clearing system for equity and debt securities (other than wholesale securities). CHESS is owned by a wholly owned subsidiary of ASX Limited, which authorises certain participants to access CHESS and settle trades. The ASX is currently preparing a replacement for CHESS, with the introduction of the replacement system to be used as soon as it is safe to do so, currently planned for April 2023.47 ASX will consider user feedback from its recent consultation in implementing the replacement, which is expected to meet current CHESS requirements of system availability, resilience, recoverability, performance and security, as well as providing services in a fair and effective way with sufficient financial, human and technological resources to operate the facility.48 Wholesale debt securities, however, are cleared in the Austraclear system, which is also owned by a wholly owned subsidiary of ASX Limited. Austraclear is not an exchange and does not provide price discovery. Instead, participants in the wholesale debt market trade on an over-the-counter basis among themselves. Debt securities may be quoted on the ASX if they are 'approved financial products' for the purposes of CHESS. Securities confined to wholesale investors may be quoted on the ASX as a wholesale debt security. These securities are cleared via Austraclear and not CHESS.

ASIC capital requirements for market participants

In 2018, ASIC consulted on proposed changes to the capital requirements for certain market participants prescribing the minimum amount of capital a participant must hold to better protect investors and market integrity by strengthening the risk profile of market participants and reducing the risk of a disorderly or non-compliant wind-up. Currently, market participants are subject to the financial requirements of the ASIC market integrity rules for capital, including certain risk-based capital requirements specific to each market participant.49 Market participants include all persons allowed to participate directly (other than principal traders or clearing participants) in any licensed financial market (i.e., ASX, ASX 24, Chi-X, SSX NSXA and FEX markets) under the operating rules of the market.50

On 16 June 2021, ASIC announced that the new ASIC Market Integrity Rules (Capital) 2021 (Capital Rules) will replace the existing separate rule books for securities market participants and futures market participants to create a common set of rules for capital. The new rules will, among other changes, move futures market participants from the existing net tangible asset regime to a risk-based regime, revise minimum core capital requirements for both futures market participants and securities market participants, and simplify capital requirements by removing redundant rules and forms. Market participants will be required to comply with the new rules from 17 June 2022.51

Hybrid securities

Many Australian financial institutions and corporates raise finance in capital markets by way of hybrid securities, being securities that combine elements of both debt securities and equity securities. The current market for such securities is dominated by financial institution issuers offering regulatory capital meeting APRA's prudential standards with Additional Tier 1 (AT1) capital being issued principally in the retail market and Tier 2 capital principally in the wholesale market. Australia's taxation system has made AT1 securities attractive to retail investors, as the securities are generally traded as equity for tax purposes and distributions carry an imputation credit that may be offset against other income. Some AT1 securities have distributions carrying an imputation credit while also giving rise to a deduction against the issuer's income outside Australia.

In December 2016, the Board of Taxation released a report following its review of the application of hybrid mismatch rules to regulatory capital in Australia.52 The Board of Taxation recommended a change in the law to facilitate treatment of AT1 capital instruments as debt for tax purposes. This would have made the securities more attractive to wholesale investors, but it was not taken up. In August 2018, the Treasury Laws Amendment (Tax Integrity and Other Measures No. 2) Bill 2018 was passed to implement the OECD hybrid mismatch rules by preventing entities that are liable to income tax in Australia from being able to avoid paying income tax by exploiting differences between the tax treatment of entities and instruments in difference countries. The law denies imputation benefits on franked distributions made by a corporate tax entity that give rise to a foreign income tax deduction, and these measures apply to returns on AT1 instruments paid on or after 1 January 2019. Transitional rules apply to AT1 capital instruments issued by ADIs, general insurance companies and life insurance companies before 9 May 2017.53

Reporting, clearing and execution of derivatives

On 6 December 2012, the commonwealth government passed amendments to the Corporations Act under which regulations may be prescribed to designate one or more of the following as mandatory obligations: the reporting of over-the-counter (OTC) derivatives to trade repositories; the clearing of standardised OTC derivatives through central counterparties; and the execution of standardised OTC derivatives on exchanges or electronic trading platforms.

On 9 July 2013, ASIC published the Derivative Transaction Rules (Reporting) 2013 and the Derivative Trade Repository Rules 2013. These rules establish which entities are required to report, what information is required to be reported to trade repositories, when the reporting obligation commences for each class of reporting entities and type of instrument, and the conditions for electronic databases of records of derivative transactions. The rules also regulate the manner in which repositories provide their services and ASIC's approach to regulation of overseas-based repositories. ASIC has granted various forms of relief from the application of the rules for specified periods of time.54 From September 2015, single-sided reporting is permitted for entities with low levels of OTC derivative transactions, provided that their counterparty is already required to or has agreed to report.55

Following extensive consultation, the Commonwealth Treasury implemented a mandatory central clearing obligation for OTC interest rate derivatives denominated in Australian dollars and G4 currencies (US dollars, euros, British pounds and Japanese yen), with effect from December 2015.56

To assist with reporting requirements, and following extensive market consultation, the ASX has established a domestic central clearing solution for participants in the Australian OTC market. In many cases, Australian institutions are finding that they have to comply with international derivative regulatory requirements without any local market infrastructure to help. The ASX's OTC clearing service is intended to fill part of this gap, in Australia's time zone, in Australia's currency, in Australia's legal system and with collateral held in Australia. On 13 January 2014, the ASX formally lodged the final form of the Operating Rules with ASIC. The ASX launched the OTC Interest Rate Derivatives Clearing Service on 1 July 2013 for dealer activity, and the Australian Client Clearing Service was launched on 7 April 2014. In mid-2017, ASX commenced use of application programming interface technology for automation of the clearing take-up process and to facilitate pre-clearing client limit checks.

End users do not have to comply with the reporting requirements under the derivative transaction rules.57 An end user is a person who is not an Australian ADI, a clearing and settlement facility licensee, an Australian financial services licensee or a person who provides financial services relating to derivatives to wholesale clients only and whose activities relating to derivatives are regulated by an overseas regulatory authority.58

Margin and collateral requirements

With effect from 1 June 2016, the Financial System Legislation Amendment (Resilience and Collateral Protection) Act 2016 has strengthened the enforceability of certain financial collateral arrangements and removed restrictions on certain Australian institutions from providing margins to clearing systems.

Non-centrally cleared derivatives: margin requirements

The revised Prudential Standard CPS 226: margining and risk mitigation for non-centrally cleared derivatives commenced on 1 October 2019 and was further revised in August 2020. CPS 226 affects certain APRA-regulated entities that transact in non-centrally cleared derivatives. Among other things, CPS 226 requires an APRA-covered entity to have appropriate margining practices in relation to non-centrally cleared derivatives and to apply risk mitigation practices (such as trading relationship documentation, trade confirmation, valuation processes and dispute resolution processes). Margin requirements apply from differing periods from 1 March 2017 onwards, depending on an entity's qualifying level under CPS 226.

Benchmark interest rate reform

In April 2018, the Treasury Laws Amendment (2017 Measures No. 5) Bill 2017 and the ASIC Supervisory Cost Recovery Levy Amendment Bill 2017 were given royal assent to establish a framework for a financial benchmark regulatory regime.59 The laws have given ASIC powers to designate significant financial benchmarks if satisfied that the designated benchmark is systemically important in Australia or there would be a material risk of financial contagion or a material impact on Australian retail or wholesale investors if there was a disruption to the operation or integrity of the benchmark. Administrators of designated significant financial benchmarks are also required to obtain a new benchmark administrator licence from ASIC, which is able to impose conditions on the grant of a licence. On 1 January 2017, ASX took over the role of administrator of Bank Bill Swap (BBSW) rates.60 In June 2018, ASIC made the ASIC Financial Benchmark (Administration) Rules 2018, which impose certain key obligations on licensed benchmark administrators and require contributors to licensed benchmarks to cooperate with ASIC.61 Previously, BBSW was the subject of litigation in 2018, when ASIC commenced legal proceedings against three of Australia's major banks for unconscionable conduct and market manipulation in setting the BBSW rate.62 Consequently, changes to BBSW administration has resulted in ASIC having power to compel the inputs to BBSW.63 The International Swaps and Derivatives Association's consultation on benchmark fallbacks identified the cash rate as the fallback rate for BBSW, and while, unlike LIBOR, there is no imminent demise of BBSW, ASX encourages market participants to have robust contractual fallback provisions to address any cessation or material change to the BBSW benchmark. These proposals aim to facilitate equivalence assessments under overseas regimes, including under the European Benchmarks Regulation. BBSW is now allowed to be used in the European Union and is also included on the European Securities and Markets Authority's register for third-country benchmarks.

Financial claims scheme and wholesale funding guarantee

As part of its response to the global financial crisis, the commonwealth government established both the Financial Claims Scheme (FCS) and the Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding.64

The FCS was amended in February 2012 and is now capped at A$250,000 per person per institution. The FCS is designed to protect depositors by providing them with timely access to their deposits in the event that their ADI becomes insolvent, and APRA has promulgated a prudential standard that requires locally incorporated ADIs to establish a 'single customer view' for balances in accounts protected under the FCS.65 This cap is estimated to protect in full the savings held in around 99 per cent of Australian deposit accounts.

A claim on the FCS would be met from commonwealth revenue. There is no compensation fund and plans to establish one have been rejected by the commonwealth.66

Corporate governance

The Australian capital markets have high expectations of corporate governance, which continues to evolve.

Directors' duties are prescribed by legislation, in particular the Corporations Act, and an extensive body of case law (common law). Directors are fiduciaries and owe stringent duties:

  1. to act honestly;
  2. to exercise care and diligence;
  3. to act in good faith in the best interests of a company and for a proper purpose;
  4. not to improperly use their position or company information; and
  5. to disclose their material personal interests and avoid conflicts of interest.

Directors have duties regarding financial and other reporting and disclosure, and can be liable under various laws, including for breaches of fundraising, anti-money laundering, environmental, competition and consumer, privacy, and occupational health and safety laws.

Some defences are available to directors, including under a limited business judgement rule in certain circumstances, for reliance on good faith after making an independent assessment and for appropriate delegation. In recent years, there has been a series of important court judgments on directors' and officers' duties, including the following:

  1. Fortescue Metals Group: the continuous disclosure requirements of the Corporations Act and the ASX Listing Rules, and the availability of the defence for a director that all steps were undertaken that were reasonable in the circumstances to ensure that the company complied with its obligations and that the director believed on reasonable grounds that the company was complying;67
  2. Centro Properties Group and Centro Retail Group: breaches by directors and officers of their duties in connection with deficiencies in annual financial reports, notwithstanding a finding by the Federal Court of Australia that these persons had acted honestly, had not intended to harm the company and had not benefited in any way in inadequately overseeing the financial reports;68
  3. James Hardie Industries: directors' duties of diligence and care in approving ASX announcements;69
  4. Cassimatis: an argument that there can be no breach of directors' duties if the directors are the sole shareholders and the company is solvent was rejected by the Court;70 and
  5. Vocation: directors were found to be in breach of their duties in connection with answers provided in a due diligence questionnaire. The Federal Court found that the business judgement rule is no defence to failing to comply with continuous disclosure obligations as decisions relating to continuous disclosure are not business judgements.71

These proceedings have prompted considerable academic and public debate as to whether there is a case for law reform in relation to the extent of the duties of directors and officers, and the defences available to them, particularly where a director or officer has made a business judgement in good faith for a proper purpose.

In addition to the liabilities imposed by the Corporations Act, a wide range of commonwealth, state and territory statutes impose personal criminal or civil liability, or both, on directors and officers for the actions of their companies. The Personal Liability for Corporate Fault Reform Act 2012 of Australia (Reform Act) commenced operation. The Reform Act has harmonised the approach of all Australian jurisdictions to personal criminal liability for corporate fault. Among other measures, it removes personal criminal liability for corporate fault unless a person is dishonestly involved in the relevant contravention, and removes the burden of proof on defendants to establish a defence to a charge.72

Crisis management of regulated entities

On 5 March 2018, the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Act 2017 was passed to strengthen APRA's crisis management powers.73 The legislation included clear powers for APRA to set resolution planning requirements and ensure banks and insurers are better prepared for times of financial crisis. The laws also equip APRA with an expanded set of crisis resolution powers to facilitate the orderly resolution of a distressed bank or insurer. The laws do not include a formal bail-in regime for debt capital instruments, although APRA does have powers to stop payments by regulated entities in certain circumstances.74

Competition laws

The Competition and Consumer Act 2010 is the primary competition and consumer protection legislation in force in Australia.75 The Act is similar to North American and European competition laws and is administered by the ACCC. The ACCC has an active enforcement policy that may affect capital markets transactions in certain circumstances. In September 2020, ACCC and ASIC signed an updated memorandum of understanding for greater information sharing, transparency and collaboration between the two agencies. The two agencies worked closely during the covid-19 pandemic in relation to issues such as authorisations on anti-competitive arrangements in the financial system.76 For example, on 30 March 2020, the ACCC granted an interim authorisation to the Australian Banking Association and its member banks to discuss, agree and give effect to arrangements to benefit their customers for the purpose of varying loan facilities, providing emergency fiscal stimulus and cost relief, and accessing banking services.77

Anti-money laundering

The Anti-Money Laundering and Counter-Terrorism Financing Act 2006 established an anti-money laundering regime that is administered by the Australian Transaction Reports and Analysis Centre. The regime covers all entities providing designated services through a permanent establishment in Australia.

Designated services include:

  1. deposit-taking;
  2. remittance services;
  3. electronic funds transfers;
  4. foreign exchange contracts;
  5. issuing and selling securities and derivatives in the course of carrying on a business of issuing securities or derivatives;
  6. redeeming a bearer bond as issuer of the bond;
  7. providing interests in managed investment schemes;
  8. lending and allowing loan transactions; and
  9. finance leasing providing custodial or depositary services, and pensions, annuities and life insurance policies.
Privacy law

The Privacy Act 1988 regulates the handling of personal information about individuals. This includes the collection, use, storage and disclosure of personal information and access to and correction of that information.

The Privacy Amendment (Enhancing Privacy Protection) Act 2012 became law in December 2012 and introduced a new statutory regime with mandatory privacy principles (Australian Privacy Principles) with which all relevant businesses must comply.78 These principles came into force on 12 March 2014.

The Australian Privacy Principles update and consolidate the privacy principles that previously applied to government agencies (i.e., the Information Privacy Principles) and private sector entities (i.e., the National Privacy Principles), and:

  1. limit the ability of agencies and organisations to use unsolicited personal information, specifically regulate the use and disclosure of personal information held by an agency or organisation for direct marketing purposes and introduce new responsibilities for agencies and organisations transferring data overseas;
  2. introduce a comprehensive scheme for credit reporting that regulates information disclosed to, and by, credit reporting bodies, credit providers and affected information recipients; and
  3. enhance the powers of the Information Commissioner so that he or she may, inter alia, conduct assessments regarding the Australian Privacy Principles.

Under the Australian Privacy Principles:

  1. an agency may only solicit and collect personal information that is reasonably necessary for, or directly related to, one or more of its functions or activities;
  2. an organisation may only solicit and collect personal information that is reasonably necessary for one or more of its functions or activities;
  3. an agency or organisation may only solicit and collect sensitive information if an individual consents to that information being collected (unless an exception applies); and
  4. an agency or organisation must only solicit and collect personal information by lawful and fair means and directly from an individual (unless an exception applies).

An agency or organisation must not use or disclose information collected for a purpose other than that for which it was collected unless an individual has consented to that other use or disclosure or an exception applies.

Personal property securities reform

The Personal Property Securities Act 2009 (PPSA) commenced operation on 30 January 2012 and introduced a national system for the registration of security interests in personal property and rules for the creation, priority and enforcement of security interests in personal property. The PPSA partially replaced the existing commonwealth and state-based regimes, including the regime under the Corporations Act for the registration of charges. The PPSA operates with retrospective effect on security interests and security agreements arising prior to the commencement of the legislation.

The PPSA was a very significant change in Australian law that affected corporate finance, bilateral and syndicated lending, leveraged and acquisition finance and project finance more significantly than the capital markets, where issues are mostly unsecured.

A secured party may need to take additional steps under the PPSA to maintain the effectiveness or priority of its existing securities. Furthermore, as a result of the broad definition of security interests under the PPSA, a secured party may need to take steps under the PPSA to maintain the effectiveness or priority of other transactions that, under the previous law, do not constitute security interests (such as retention of title arrangements, certain leases, securitisation transactions and certain subordination arrangements). The system has been substantially modelled on the personal property regimes in New Zealand, Canada and the United States.

In 2014, the commonwealth government conducted a review of the operation and effects of the PPSA. The commonwealth government considered the recommendations of the review and amended the PPSA to implement some of them.79

Commonwealth bank levy

In June 2017, the commonwealth government passed legislation to impose a major bank levy. The levy applies to a limited number of ADIs and is imposed by reference to certain liabilities of the relevant ADI, including corporate bonds, commercial paper, certificates of deposit and Tier 2 capital instruments, at a rate of 0.015 per cent per quarter.

Financial system inquiry

In October 2015, the government released its response to the financial system inquiry, which released its final report on 7 December 2014. The response sets out an agenda for improving the financial system that rests on five strategic priorities, including:

  1. resilience measures that aim to reduce the impact of potential future crises;
  2. superannuation and retirement income measures that aim to improve the efficiency and operation of the superannuation system;
  3. innovation measures that will unlock new sources of finance and support competition;
  4. consumer outcome measures designed to increase consumer confidence both in participation in the financial system and that consumers are being treated fairly; and
  5. regulatory system measures that aim to make regulators more accountable and more effective.80

As yet there is no comprehensive legislation to address all the recommendations, but the report and continued public scrutiny of financial institutions have prompted a large number of specific initiatives as well as continuing inquiries.

Penalties

In March 2019, the commonwealth government passed legislation to strengthen penalties in the corporate and financial sector in response to the Royal Commission into misconduct in financial services. The legislation introduced stronger civil penalty provisions in Part 7.7A of the Corporations Act, the ASIC Act, the National Consumer Credit Protection Act 2009 and the Insurance Contracts Act 1984.81

Competition

In May 2017, the government announced plans to enhance competition in the banking industry, which include:

  1. a new open banking regime to increase access to banking products and consumer data by consumers and third parties if consumers consent. The Open Banking Review was commissioned in July 2017 and the final report was released in February 2018. The report made 50 recommendations on the regulatory framework, the type of banking data in scope, privacy and security safeguards for banking customers, the data transfer mechanism and implementation issues. The open banking regime has a phased implementation timetable and commenced on 1 July 2020 in relation to deposits, transaction accounts, and credit and debit cards. The effects of the open banking regime are not yet known.82
  2. reducing regulatory barriers to entry for new and innovative entrants; and
  3. tasking the Productivity Commissioner and the ACCC to review the state of competition in the financial system. The Productivity Commission's final report, dated 3 August 2018, has made a number of recommendations to improve consumer outcomes through increasing competition.83

In June 2018, an ACCC investigation also led to criminal cartel charges laid against three major financial institutions – ANZ, Citigroup and Deutsche Bank – relating to trading in ANZ shares held by both Citigroup and Deutsche Bank. The cartel conduct is alleged to have taken place following an ANZ institutional share placement in August 2015. Criminal charges were laid against several senior executives of these financial institutions.84 The case is due to be heard in the Federal Court of Australia.85 In September 2018, ASIC also commenced proceedings to pursue ANZ over allegations that it failed to comply with its continuous disclosure obligations under the corporations law in relation to the same placement.86 The outcome of these proceedings and any implications for capital markets may not be known for some time.