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



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ISSN 1328-8091

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BILLS DIGEST NO. 80, 2017-18 14 FEBRUARY 2018

Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 Paula Pyburne Law and Bills Digest Section

Phillip Hawkins Economics Section

Contents

The Bills Digest at a glance ................................................... 4

Purpose of the Bill ............................................................... 5

Structure of the Bill ............................................................. 5

Background ......................................................................... 5

Policy Commitment ................................................................. 5

Context—the Global Financial Crisis ....................................... 5

Resolution regimes .................................................................. 6

Attributes of a resolution regime .......................................... 6

Bank Capital ........................................................................... 7

TLAC standard ....................................................................... 7

Committee consideration .................................................... 7

Senate Standing Committee on Economics ............................. 7

Senate Standing Committee for the Scrutiny of Bills .............. 8

Policy position of non-government parties/independents ..... 8

Position of major interest groups ......................................... 8

Financial implications .......................................................... 8

Statement of Compatibility with Human Rights .................... 8

Parliamentary Joint Committee on Human Rights .................. 8

Amending the Banking Act ................................................... 9

About authorisation ................................................................ 9

Strengthening the authorisation process .............................. 9

Revoking an authority ......................................................... 10

Application by a related body corporate ............................... 10

Date introduced: 19 October 2017

House: House of Representatives

Portfolio: Treasury

Commencement: On Royal Assent

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 2018.

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Extending authorisation to a NOHC .................................... 10

Conversion and write off provisions ...................................... 11

Stakeholder comments ....................................................... 13

Application to deposits ..................................................... 13

Risks of hybrid securities ................................................... 14

Directions power—early intervention ................................... 15

Expanding the directions power ......................................... 15

Recapitalisation directions .................................................. 16

Secrecy provisions ................................................................. 17

Protection from liability ...................................................... 18

Scrutiny of Bills Committee ................................................. 18

Position of stakeholders ...................................................... 19

Permitted disclosures ............................................................ 19

Statutory management ......................................................... 20

Exercise of control by APRA or statutory manager ............... 20

Termination of control ........................................................ 22

Statutory manager’s powers and functions .......................... 22

Safeguards ........................................................................... 22

APRA-appointed administrator ............................................. 23

Recommendations .............................................................. 23

Immunity ............................................................................. 23

Interaction with the Corporations Act ................................ 23

Termination of appointment ................................................. 24

Moratorium ........................................................................... 24

Scrutiny of Bills Committee ................................................. 25

Winding up an ADI ................................................................. 26

Application for winding up an ADI ......................................... 26

No denial of obligations ...................................................... 26

Access to the financial claims scheme ................................... 26

About the FCS ...................................................................... 26

Transferred liabilities determination ..................................... 27

Winding up and foreign ADIs ................................................. 28

Amending the Insurance Act .............................................. 28

Background ............................................................................ 28

Authorisation ......................................................................... 29

Conversion and write-off provisions ..................................... 30

Judicial management ............................................................. 30

Moratorium ........................................................................... 30

Appointment of judicial manager .......................................... 30

Statutory management of general insurers .......................... 31

Scrutiny of Bills Committee ................................................. 31

Human Rights Committee ................................................... 32

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Recapitalisation ................................................................... 33

Administrator in control of an insurer ................................... 33

Winding up ............................................................................ 34

Financial claims scheme ........................................................ 34

Recapitalisation directions .................................................... 35

Secrecy and disclosure .......................................................... 35

Protection from liability ...................................................... 35

Amending the Life Insurance Act ........................................ 35

Background ............................................................................ 35

Registration ........................................................................... 36

Judicial management ............................................................. 37

Statutory management of life companies ............................. 37

Winding up a life company .................................................... 38

Conversion and write off provisions ...................................... 38

Other provisions ................................................................ 40

Schedule 4 ............................................................................. 40

Concluding comments ....................................................... 40

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The Bills Digest at a glance The purpose of the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 is to amend a number of statutes and so to provide the Australian Prudential Regulation Authority with an enhanced suite of crisis resolution powers.

Schedules 1-3 of the Bill amend the Banking Act 1959, the Insurance Act 1973 and the Life Insurance Act 1995 respectively to ensure that each of those statutes contains provisions in equivalent (or near equivalent) terms in relation to:

• authorisation to carry on a banking business or general insurance business and registration of a life company—including by extending the authorisation requirement to a non-operating holding company (NOHC)

• the process by which an authority or registration may be revoked

• formal conversion and write off provisions

• APRA’s power to make binding directions—including recapitalisation directions

• secrecy and disclosure provisions relating to APRA’s directions

• judicial management for an general insurance business or a life company

• statutory management of an ADI, a general insurance business or a life company—including the powers and functions of a statutory manager, the reasons for appointment and the termination of control by a statutory manager

• the appointment of an external administrator

• moratorium provisions to temporarily prevent creditors and others from taking litigious and enforcement actions

• the winding up of an ADI, general insurance business or a life company—including access to the financial claims scheme and

• dealing with Australian branches of foreign entities.

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Purpose of the Bill The purpose of the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 (the Bill) is to amend a number of statutes and so to provide the Australian Prudential Regulation Authority (APRA) with an enhanced suite of crisis resolution powers. Those powers will apply to prudentially regulated authorised deposit-taking institutions (ADIs), general insurers and life insurance companies as well as certain group entities.

Structure of the Bill The Bill comprises seven Schedules:

• Schedule 1 amends the Banking Act 1959

• Schedule 2 amends the Insurance Act 1973

• Schedule 3 amends the Life Insurance Act 1995

• Schedule 4 amends the Financial Sector (Business Transfer and Group Restructure) Act 1999 including changing its name to the Financial Sector (Transfer and Restructure) Act. For consistency, references to this statute will be references to the FSTR Act, throughout this Bills Digest.

• Schedule 5 amends the Payment Systems and Netting Act 1998

• Schedule 6 amends the Australian Prudential Regulation Authority Act 1998 (APRA Act)

• Schedule 7 amends the Corporations Act 2001 and the Income Tax Assessment Act 1997 (ITAA 1997).

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

Background Policy Commitment The final report of the 2014 Financial System Inquiry (FSI) made a number of recommendations to improve the resilience of Australia’s financial system and enhance the ability of regulators to deal with a financial crisis. The FSI final report states

The toolkits available to regulators to prevent distress and resolve failing financial institutions are critical and should be enhanced. ADIs should also maintain sufficient loss absorbing and recapitalisation capacity to allow effective resolution with minimal risk to taxpayer funds, in line with emerging international practice. As this area is complex and evolving, Australia should take a cautious approach in developing requirements for such capacity.

1

The Government released its response to the FSI in October 2015 and committed to strengthen APRA’s regulatory framework to increase financial sector resilience.

Australia’s financial sector regulatory framework needs to be stronger than those of comparable economies. The resilience measures will ensure the banking system is more stable by holding more capital, and will address risk weights, leverage, loss absorbency and regulators’ crisis management powers. 2

The proposals in this Bill seek to implement aspects of this commitment, specifically those related to loss-absorbency of regulatory capital and APRA’s crisis management powers.

Context—the Global Financial Crisis The global financial crisis (GFC) demonstrated that instability in financial markets can have significant flow on effects to tax-payers and the economy. While it is generally regarded that Australia weathered the GFC well, Australia was not immune from the effects of financial market dislocation in international markets.3 The GFC exposed weaknesses in prudential regulation and supervision in a number of financial institutions globally and necessitated Government intervention to protect economies.

1. Financial System Inquiry (FSI), Financial systems inquiry: final report, The Treasury, November 2014, p. 36. 2. Australian Government, Improving Australia’s financial system: Government response to the financial system inquiry, p. 4. 3. FSI, Financial systems inquiry: final report, op. cit., p. 8.

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At the G20 Leaders’ Summit in Washington in November 2008 Leaders resolved to strengthen international regulatory cooperation and the consistency of international standards. The Leaders statement states:

Regulation is first and foremost the responsibility of national regulators who constitute the first line of defense against market instability. However, our financial markets are global in scope, therefore, intensified international cooperation among regulators and strengthening of international standards, where necessary, and their consistent implementation is necessary to protect against adverse cross-border, regional and global developments affecting international financial stability.

4

One of the actions agreed to by the G20 was the establishment of the Financial Stability Board by enhancing the existing Financial Stability Forum.5 The Financial Stability Board is an international body made up of policy agencies from a number of major world economies (including Australia) that makes recommendations about the global financial system.

Resolution regimes In the context of a banking crisis, the literature refers at first instance to resolving a financial institution—that is taking steps to resolve the financial distress of the entity rather than allowing it to fail in which case it would be wound up.

Attributes of a resolution regime In October 2011, the Financial Stability Board issued its Key Attributes of Effective Resolution Regimes for Financial Institutions (Key Attributes). The Key Attributes set out relatively comprehensive principles on the resolution of financial institutions. According to the Key Attributes, an effective resolution regime should:

• ensure continuity of systemically important financial services and payment, clearing and settlement functions

• protect, where applicable and in coordination with the relevant insurance schemes and arrangements such depositors, insurance policyholders and investors as are covered by such schemes and arrangements, and ensure the rapid return of segregated client assets

• allocate losses to firm owners (shareholders) and unsecured and uninsured creditors in a manner that respects the hierarchy of claims

• not rely on public solvency support and not create an expectation that such support will be available

• avoid unnecessary destruction of value, and therefore seek to minimise the overall costs of resolution in home and host jurisdictions and, where consistent with the other objectives, losses for creditors

• provide for speed and transparency and as much predictability as possible through legal and procedural clarity and advanced planning for orderly resolution

• provide a mandate in law for cooperation, information exchange and coordination domestically and with relevant foreign resolution authorities before and during a resolution

• ensure that non-viable firms can exit the market in an orderly way and

• be credible and thereby enhance market discipline and provide incentives for market-based solutions. 6

In this context, the types of resolution powers that should be available for dealing with financial institution distress include robust statutory powers to:

• issue binding directions to ADIs, general insurers and life insurers supervised by APRA (regulated entities), including the removal and replacement of directors and management

• appoint an administrator to assume control of a regulated entity

• implement resolution of distress in respect of financial groups, including holding companies and subsidiaries

• implement resolution of distress in a branch of a foreign bank or insurer

4. G20 Leaders, Declaration: summit on financial markets and the world economy, 15 November 2008, p. 2. 5. G20 Leaders, Declaration on strengthening the financial system - London, 2 April 2009, p. 1. 6. The Treasury, Strengthening APRA’s crisis management powers, The Treasury website, consultation paper, September 2012, pp. 4-5.

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• transfer some or all of the business of an entity or group to another entity as part of a resolution process

• override shareholder rights where required

• establish a bridge institution

• suspend or cancel financial obligations and

• facilitate bail-in. 7

Bank Capital One of the most important prudential regulatory approaches to avoiding bank failure is requiring prudentially regulated financial institutions to satisfy minimum capital requirements. Capital essentially reflects a financial institution’s ability to withstand losses without becoming insolvent.8 Bank capital, in its simplest form, represents a bank's ability to absorb expected losses on its assets without impacting on its ability to repay debt holders or depositors.

The Australian Prudential Regulatory Authority (APRA) sets standards on the amount of capital that Australian banks are required to hold. These are set in line with international standards established by the Basel Committee on Banking Supervision (BCBS), which were strengthened following the global financial crisis, with the BCBS finalising the key aspects of its ‘Basel III’ capital framework in June 2011.9

TLAC standard In November 2015, the G20 leaders endorsed a new Financial Stability Board standard for Total Loss-absorbing Capacity (TLAC).10 The finalisation of the TLAC standard was a significant milestone in the international policy reform agenda to address the problem of ‘too big to fail’ where the threatened failure of a systemically important financial institution leaves authorities with no alternative but to capitalise it using public funds (that is to ‘bail out’). TLAC has been developed with a focus on globally-systemically important Banks (G-SIBs), Australian banks are not considered G-SIBS, but the TLAC standard has nevertheless informed regulatory developments in Australia.11

The TLAC standard builds on a significant body of international regulatory reform already undertaken by the Financial Stability Board to improve resolution frameworks for globally significant financial institutions. In particular, it builds on the Key Attributes which specifies that Financial Stability Board jurisdictions should have in place legally enforceable mechanisms to implement a ‘bail-in’.12

The purpose of the TLAC standard is to ensure that, in the event of a bank crisis, there is a mechanism to stop the contagion to other banks and cut the possible domino effect by allowing public authorities to spread unmanageable losses on bank shareholders and creditors.13 Importantly, it is designed to ensure that a failing bank will not, and does not expect to be, bailed-out by the Government and taxpayers.

TLAC requires banks to hold additional capital above their Basel III capital requirements. Instruments with conversion or write-off features are anticipated to be a significant component of TLAC requirements.

Committee consideration Senate Standing Committee on Economics The Bill was referred to the Senate Standing Committee on Economics (Economics Committee) for inquiry and report by 9 February 2018.14

7. Ibid., p. 5.

8. A Gorajek and G Turner, ‘Australian bank capital and the regulatory framework’, Reserve Bank of Australia Bulletin, September Quarter, 2010. 9. Reserve Bank of Australia (RBA), The Basel III capital reforms in Australia, RBA website. 10. Financial Stability Board, FSB issues final Total Loss-Absorbing Capacity standard for global systemically important banks, media release, 9 November 2015. 11. W Byres (Chairman APRA), ‘From strength to resilience’, Address to AFR Banking & Wealth Summit, Sydney, speech, 5 April 2016. 12. P Smith and N Tan, ‘Total loss-absorbing capacity’, Reserve Bank of Australia Bulletin, December Quarter, 2015, pp. 59-66. 13. DG Internal Market, Discussion paper on the debt write-down tool—bail-in, European Commission website. 14. The terms of reference for the inquiry, submissions to the Economics Committee and the Committee’s final report are available on the inquiry

homepage.

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The Economics Committee stated:

The committee is satisfied that depositors are protected both by the [Financial Claims Scheme] and under the Banking Act. Under the FCS, the Australian Government guarantees the prompt repayment of deposits at a failed Australian ADI of up to $250 000 per depositor. The Banking Act includes 'depositor-preference provisions' which give depositors priority over most other creditors in the winding up of an ADI or insurer, to the extent that depositors have not already been paid out by the FCS.

15

The Economics Committee recommended that the Bill be passed.16 The report does not contain dissenting comments.

Senate Standing Committee for the Scrutiny of Bills The Senate Standing Committee for the Scrutiny of Bills (Scrutiny of Bills Committee) considered the Bill and made requests from the relevant Minister in relation to its concerns.17 Those concerns and the Minister’s response are set out below.

Policy position of non-government parties/independents The Australian Labor Party (ALP) has expressed its support for the measures in the Bill. Speaking in relation to the Bill, Shadow Treasurer, Chris Bowen described the Bill as ‘very sensible legislation’.

This Bill strengthens APRA's management powers in both preventing and responding to a financial crisis. Of course, everybody knows a financial crisis is unlikely, or is very much the exception. But it is also the case that we should make sure that our regulatory practices are best practice, up to date and maximise the chances of avoiding a crisis in the first place and responding rapidly and appropriately, should such a crisis emerge.

18

Position of major interest groups A number of submissions have been made to the Senate Economics Legislation Committee (the Economics Committee) Inquiry into the Bill. The majority of submissions from industry groups and the regulators broadly supported the reforms.

However, a number of submissions raised concerns about specific elements of the Bill, most notably changes to provisions relating to the conversion of write-off of certain financial instruments, and on the compatibility of secrecy provisions with foreign laws. These specific stakeholder views are discussed in the relevant sections of the Bills Digest.

The submissions made to the Economics Committee primarily reflected on the proposed changes to the legislation affecting the banking sector.

Financial implications According to the Explanatory Memorandum, the Bill will not create a financial impact for the Government.19

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.20

Parliamentary Joint Committee on Human Rights The Parliamentary Joint Committee on Human Rights (the Joint Committee) reported on the Bill in its Scrutiny Report of 28 November 2017 and sought further advice from the Treasurer on a number of aspects of the Bill.21

15. Senate Standing Committee on Economics, Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 [Provisions], Senate, Canberra, February 2018, p. 22. 16. Ibid.

17. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 13, 2017, The Senate, Canberra, November 2017, p. 28. 18. C Bowen, ‘Second reading speech: Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017’, House of Representatives, Debates, 12 February 2018, p. 74. 19. Explanatory Memorandum, Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017, p. 5. 20. The Statement of Compatibility with Human Rights can be found at pages 217-28 of the Explanatory Memorandum to the Bill.

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The Treasurer responded to the Joint Committee on 14 December 2017.22 The issues identified by the Joint Committee and the Treasurer’s responses are set out below.

Amending the Banking Act About authorisation A key aspect of the prudential regulation framework is the capacity to control entry into the market to ensure that entities undertaking regulated activities and the individuals responsible for ensuring the financial soundness of those entities, meet certain minimum standards. Authorisation serves to control access to prudentially regulated segments of the financial services market which would otherwise be open to unrestricted entry.23

Currently, the authorisation power is primarily concerned with the entity that will be undertaking the regulated activity.

Schedule 1 to the Bill:

1. strengthens the authorisation process for ADIs and

2. extends the authorisation requirement to a non-operating holding company (NOHC).

Strengthening the authorisation process Section 9 of the Banking Act requires a body corporate to apply in writing to APRA for authority to carry on a banking business. Where the authority is granted, APRA must ensure that notice of the authority is published in the Gazette.24

The Bill empowers APRA to impose conditions, or additional conditions, or to vary or revoke existing conditions on the body corporate’s authority at any time. Those conditions must relate to prudential matters.25

What are prudential matters?

The Bill repeals and replaces the definition of the term prudential matters so that it relates to:

• the conduct of any part of the affairs of, or the structuring or organising of, an ADI, an authorised NOHC,26 a relevant group of bodies corporate, or a particular member or members of such a group, in such a way as:

- to keep the ADI, NOHC, group or member or members of the group in a sound financial position

- to facilitate resolution of the ADI, NOHC, group or member or members of the group

- to protect the interests of depositors of any ADI

- not to cause or promote instability in the Australian financial system or

- not to cause or promote instability in the New Zealand financial system

• the conduct of any part of the affairs of an ADI, an authorised NOHC, a relevant group of bodies corporate, or a particular member or members of such a group, with integrity, prudence and professional skill.27

A person who is affected by a decision to impose conditions, or additional conditions, or a decision to vary conditions that have been imposed on an authority to carry on a banking business may ask APRA to reconsider the decision.28 If APRA confirms or varies the decision, the person may make an application for review to the Administrative Appeals Tribunal.29

21. Parliamentary Joint Committee on Human Rights, Human rights scrutiny report, 12, 28 November 2017, pp. 25-30. 22. Parliamentary Joint Committee on Human Rights, Human rights scrutiny report, 1, 6 February 2018, pp. 96-107. 23. The Treasury, Strengthening APRA’s crisis management powers, op. cit., p. 103. 24. Banking Act, subsection 9(7) and proposed subsection 9(4). 25. Banking Act, proposed subsection 9AA(1) inserted by item 14 of Schedule 1 to the Bill. 26. Section 5 of the Banking Act provides that NOHC is short for non-operating holding company (see discussion below). An authorised NOHC

means a body corporate which is currently authorised under subsection 11AA(2) of the Banking Act and is a NOHC of an ADI or ADIs. 27. Banking Act, subsection 5(1), inserted by item 8 of Schedule 1 to the Bill. 28. Banking Act, proposed subsection 9AA(6). Part VI of the Banking Act provides for the reconsideration and review of decisions. 29. Banking Act, sections 51B and 51C.

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A body corporate commits an offence of strict liability30 if it does an act or fails to do an act and as a result contravenes a condition of its authority to carry on a banking business.31 In that case the maximum penalty is 300 penalty units.32 An individual may commit the offence because of the provisions in Part 2.4 of the Criminal

Code Act 1995, which extend criminal responsibility to a person who attempts to commit an offence, who aids abets, counsels, procures or incites the commission of an offence, or conspires with another person to commit an offence. The maximum penalty for an individual is a fine not exceeding 60 penalty units. 33

Revoking an authority Existing subsection 9A(2) of the Banking Act sets out the matters about which APRA is to be satisfied in making a decision to revoke an authority to carry on a banking business. Item 16 of the Bill repeals and replaces subsection 9A(2). Much of the content is unchanged and merely renumbered. The list of legal requirements with which a body corporate must comply—or face the prospect that its authority will be revoked—has been expanded and reworded for clarity.34

In addition, the Bill provides that APRA may revoke a body corporate’s authority to carry on a banking business if it is satisfied:

• the body corporate is a foreign corporation35 within the meaning of paragraph 51(xx) of the Constitution

• it is unlikely to be able to meet its liabilities in Australia and is unlikely to be able to do so within a reasonable period of time or

• the authority to carry on a banking business in a foreign country has been revoked or otherwise withdrawn in that foreign country.36

Application by a related body corporate Under existing section 11AA of the Banking Act a body corporate may apply to APRA for an authority in relation to the body corporate and any ADIs that are subsidiaries of the body corporate from time to time. APRA may impose conditions, or additional conditions, on the authority and vary or revoke conditions that have been imposed. Item 17 of Schedule 1 to the Bill repeals subsections 11AA(3)-(8) of the Banking Act which deal with the imposition of conditions on such an authority and the consequences of not complying with them.

In its place proposed sections 11AAA and 11AAB of the Banking Act (which are inserted by item 18 of Schedule 1 to the Bill) set out APRA’s power to impose conditions on an authority which is granted following an application from a body corporate and the applicable penalties in the event of a breach of a condition respectively. They are in equivalent terms to those which apply to a body corporate which is authorised to carry on a banking business under section 9 of the Banking Act.37 Item 20 repeals and replaces paragraph 11AB(2)(a) of the Banking Act so that APRA may revoke an authority granted under section 11AA in certain circumstances.

Extending authorisation to a NOHC A holding company is a body corporate that controls the composition of another body corporate's board of directors, is in a position to cast, or control the casting of, more than one half of the maximum number of votes that might be cast at a general meeting of another body corporate, or holds more than one half of the issued share capital of another body corporate (excluding any part of that issued share capital that carries no right to participate beyond a specified amount in a distribution of either profits or capital).38

30. In a criminal law offence, the proof of fault is usually a basic requirement. However, offences of strict liability remove the fault (mental) element that would otherwise apply, but the offence will not criminalise honest errors and a person cannot be held liable if he, or she, had an honest and reasonable belief that they were complying with relevant obligations. 31. Banking Act, proposed subsection 9AB(1). 32. Under section 4AA of the Crimes Act 1914 a penalty unit is equivalent to $210. This means that the maximum penalty for the offence is

$63,000.

33. This means that the maximum penalty is $12,600. 34. Banking Act, proposed paragraph 9A(2)(b). 35. A foreign corporation is a corporation incorporated outside Australia which carries on business within Australia. See: New South Wales v Commonwealth (1990) 169 CLR 482, [1990] HCA 2; Re Dingjan; Ex parte Wagner (1995) 183 CLR 323, [1995] HCA 16.

36. Banking Act, proposed paragraph 9A(2)(j). 37. That is, proposed sections 9AA and 9AB of the Banking Act which are inserted by item 14 of Schedule 1 to the Bill. 38. Butterworth's Concise Australian Legal Dictionary, one 3rd edition, LexisNexis Butterworths, Australia, 2004, p. 202.

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A non-operating holding company of a body corporate is a body corporate:

• of which the first body corporate is a subsidiary

• that does not carry on a business (other than a business consisting of the ownership or control of other bodies corporate) and

• that is incorporated in Australia.39

A NOHC may advantage a financial services group by enhancing operational flexibility and risk management capacity. However the downside to such an arrangement may be increased prudential risk. According to Treasury:

If a regulated entity is in financial distress, and is part of a group, it may be necessary to maintain the continued operation of the NOHC and/or subsidiaries in order to achieve an orderly resolution of the regulated entity. The inability to control such entities could jeopardise the capacity to implement an effective resolution. It may also be necessary to ensure that the NOHC, in its capacity as the controlling shareholder of the ADI or insurer, takes the steps required to facilitate the resolution of the ADI or insurer.

40

Despite this, the Banking Act does not currently require a NOHC to be authorised.

That being the case, Schedule 1 to the Bill empowers APRA to give a NOHC a notice in writing requiring it to ensure, by a specified time or within a specified period, that it either becomes an authorised NOHC of the ADI or one of its subsidiaries becomes an authorised NOHC of the ADI.41 The provisions of Part VI of the Banking Act which deal with the reconsideration and review of decisions apply to a decision to give such a notice.42 The body corporate is empowered to comply with the notice despite anything in its constitution or any contract or arrangement to which it is a party.43

Items 23-28 of Schedule 1 to the Bill amend section 11AF of the Banking Act so that APRA may also make standards about the subsidiaries of ADIs or authorised NOHCs; a specified class of subsidiaries of ADIs or authorised NOHCs or one or more subsidiaries of ADIs or authorised NOHCs.44 The standards may impose different requirements to be complied with in different situations or in respect of different activities.45 Item 29 of Schedule 1 to the Bill inserts proposed section 11AG into the Banking Act so that an ADI, authorised NOHC or a subsidiary of an ADI or authorised NOHC to which a prudential standard applies must comply with the standard.

Conversion and write off provisions As part of the Basel III capital reforms, APRA introduced new loss absorbency criteria for regulatory capital instruments in January 2013.46 Subsequently the Government issued a consultation paper setting out various legislative amendments that were:

… intended to ensure that contractual loss absorption provisions contained in Additional Tier 1 and Tier 2 capital instruments issued by authorised deposit-taking institutions (ADIs), general insurers (GIs) and life insurers (LIs) operate as intended and are not rendered ineffective by provisions in the Corporations Act 2001 that may restrict the ability of companies to issue, vary, convert or cancel shares.

47

Item 31 of Schedule 1 to the Bill inserts proposed Subdivision B—Conversion and write-off provisions into Division 1A of Part II of the Banking Act which is to apply to certain financial instruments.

39. Defined in subsection 5(1) of the Banking Act. 40. The Treasury, Strengthening APRA’s crisis management powers, op. cit., p. 10. 41. Banking Act, proposed subsections 11AE(2) and (3) inserted by item 21 of Schedule 1 to the Bill. 42. Banking Act, proposed subsection 11AE(7). 43. Banking Act, proposed subsection 11AE(4). 44. Banking Act, proposed paragraphs 11AF(1)(c)-(e). 45. Banking Act, proposed subsection 11AF(1A). 46. M Cormann (Minister for Finance), Providing certainty for contractual loss absorption provisions in regulatory capital, media release,

2 June 2014. 47. The Treasury, Providing certainty for contractual loss absorption provisions in regulatory capital, consultation paper, June 2014, p. iii.

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What are financial instruments?

Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled.

The Australian Accounting Standards Board made Accounting Standard AASB 132 which defines a financial instrument as ‘any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity’.

What are hybrid financial instruments?

Certain financial instruments issued by financial institutions may contain contractual provisions which allow for them to be converted into ordinary equity or written-off upon certain trigger events such as where APRA makes a recapitalisation direction.

The types of instruments that include these types of provisions are typically a type of ‘hybrid security’ because they incorporate features of both debt and equity instruments, for example, they may pay interest like a debt instrument, but if converted rank alongside equity in liquidation.48

Hybrid securities can be known by a number of names, including subordinated notes, capital notes and convertible preference shares.49 Hybrids issued by banks are required to have the loss absorption criteria necessary to meet the banks’ TLAC requirements.50 With increases in banks’ capital requirements in recent years, issuances of hybrid securities have grown significantly.

According to Australian Securities and Investments Commission (ASIC), Australia’s hybrid sector was around $43.3 billion as at the end of June 2017, an expansion of around 44 per cent in two years.51 In 2013 it was estimated that self-managed superannuation funds account for around two-thirds of investment in hybrid securities.52

Specifically, proposed section 11CAB applies to an instrument that contains terms for the purposes of the conversion and write-off provisions and that is issued by, or to which any of the following is, a party:

• an ADI, a holding company of an ADI or a subsidiary or related subsidiary of an ADI53 or

• an entity of a kind prescribed by the regulations.

About Banking (Prudential Standard) Determination No. 3 of 2015

The Prudential Standard APS 330 Public Disclosure (APS 330) took effect on 1 August 2015. It requires an ADI to make accurate, high quality and timely public disclosures of information on, amongst other things, its capital instruments. The relevant clauses are:

• all ADIs to which APS 330 applies must make the disclosures in Attachments A and B of the prudential standard and must disclose the full terms and conditions of instruments included in their Regulatory Capital in accordance with the provisions of this Prudential Standard: clause 10

• if APRA is not satisfied with the adequacy or quality of an ADI’s prudential disclosures it may require the ADI to rectify the disclosures or to disclose further information: clause 23

• an ADI that has its own website must include a ‘Regulatory Disclosures’ section on its website: clause 32

• the disclosures required in Attachment B of APS 330 and the full terms and conditions of Regulatory Capital instruments must be published continuously. The disclosures must be updated within seven calendar days if a new capital instrument is issued and included in Regulatory Capital or a capital instrument is redeemed, converted into Common Equity Tier 1 Capital, written off or otherwise changes in nature: clause 41.

These measures ensure that ADI customers do not unknowingly purchase a financial instrument to which the conversion and write-off provisions apply.

48. ASIC, Hybrid securities, Report 365, August 2013, p. 6. 49. Ibid.

50. Ibid., p. 8. 51. Senate Economics Legislation Committee, Official committee Hansard, 26 October 2017, p. 30; ASIC, ASIC’s Corporate Plan 2017-18 to 2020- 21, ASIC website, August 2017, p.10. 52. ASIC, Hybrid securities, op. cit., p. 4. 53. Banking Act, proposed section 11CAA, provides that a related subsidiary of an ADI means a subsidiary of a holding company of the ADI.

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In support of the new Subdivision, the Bill inserts a range of definitions. In particular, the term conversion and write-off provisions means the provisions of the prudential standards that relate to the conversion or writing off of Additional Tier 1 and Tier 2 capital, or to any other instrument.54

The Bill provides for instruments to be converted into one or more ordinary shares or mutual equity interests55 of an entity including by redeeming or cancelling the instrument or rights under the instrument.56 The instrument may be converted in accordance with its terms despite:

• any Australian law or any law of a foreign country or a part of a foreign country (other than a specified law)

• the constitution of the relevant entity being the entity issuing the instrument, any entity that is a party to the instrument and any conversion entity for the instrument57

• any contract or arrangement to which a relevant entity is a party

• any listing rules or operating rules of a financial market in whose official list a relevant entity is included58 and

• any operating rules of a clearing and settlement facility through which the instrument is traded.59

The Bill provides that the instrument may be written off in accordance with its terms—subject to similar conditions as those which apply for conversion.60

Whether an instrument is being converted, or being written off, in accordance with its terms, or due to the making of a determination by APRA the Bill provides that this does not allow the contract, or a party to the contract (other than the first entity), to do the following:

• deny any obligation under the contract

• accelerate any debt under the contract

• close out any transaction relating to the contract or

• enforce any security under the contract.61

Stakeholder comments Some of the submissions to the Senate Economics Inquiry into the Bill raised specific concerns about the write-off and conversion provisions in the Bill.62 The claims made include:

• the legislation would allow for the conversion or the writing-off of people’s bank deposits and

• these instruments are currently being sold to investors that are insufficiently informed about the potential risks.

Application to deposits The current legal framework for conversion and write-off does not apply to deposit accounts nor does the Bill allow APRA to write-off deposits or convert them to equity.

First the conversion and write-off provisions contained in the Bill clearly only apply ‘in relation to an instrument that contains terms for the purposes of the conversion and write-off provisions’.63 Under APRA’s existing powers

54. Banking Act, proposed section 11CAA, inserted by item 31 of Schedule 1 to the Bill. 55. Banking Act, proposed section 11CAA, provides that mutual equity interests has the same meaning as in the prudential standards. 56. Banking Act, proposed section 11CAA. 57. Banking Act, proposed section 11CAA provides that an entity (the first entity) is a conversion entity for an instrument if (a) the instrument is

issued by another entity, or another entity is a party to the instrument and (b) the instrument converts, in accordance with the terms of the instrument, into one or more ordinary shares or mutual equity interests of the first entity. 58. Banking Act, proposed section 11CAA, provides that the term operating rules has the meaning given by section 761A of the Corporations Act 2001. 59. Banking Act, proposed subsection 11CAB(2). Proposed section 11CAA, provides that the term clearing and settlement facility has the

meaning given by Division 6 of Part 7.1 of the Corporations Act. 60. Banking Act, proposed subsection 11CAB(3). 61. Banking Act, proposed subsection 11CAC(2). 62. See for example, submissions from the Citizens Electoral Council and the Banking and Finance Consumers Support Association (Inc.). 63. Banking Act, proposed subsection 11CAB(1).

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to stipulate conversion and write-off which are set out in Prudential Standard APS 330 Public Disclosure, ADIs are required to make accurate, high quality and timely public disclosures of information about their capital instruments.

Second a basic deposit product, as defined under section 761A of the Corporations Act 2001, must meet certain conditions. These include limitations on the circumstances under which the balance of a deposit account can be reduced. These circumstances do not include conversion or write-off.

Third APRA has a statutory obligation to protect the interests of depositors under Division 2 of Part II of the Banking Act, which states:

It is the duty of APRA to exercise its powers and functions under this Division [Division 2 of Part II of the Banking Act] for the protection of the depositors of the several ADIs and for the promotion of financial system stability in Australia. 64

This statutory obligation applies to APRA’s powers to issue a recapitalisation direction under Subdivision AA of Division 2 of Part II of the Banking Act.

Australia also has a number of specific protections in place to protect depositors. This includes the Financial Claims Scheme (FCS) which operates specifically to protect the interests of depositors. In the unlikely event that a bank fails the Treasurer may activate the FCS. This would require APRA to provide depositors with access to their deposits within seven days up to the $250,000 cap protected by the FCS.65 It is estimated that the $250,000 cap covers around 99 per cent of deposit accounts in full and around 80 per cent of household deposits by value.66

Deposits above the cap benefit from Australia’s system of depositor preference which means that in the event that a bank fails the claims of depositors rank above all equity holders and creditors (after the Government has been reimbursed for any amounts paid out under the FCS).67

These specific depositor protections would generally only apply as a last resort, once an ADI cannot be resolved. They exist on top of the numerous layers of prudential regulation (including capital requirements and ADI risk management requirements) and the interventions that APRA can make to resolve financial institutions that are in distress (such as recapitalisation, statutory management and transfer powers). Further, an ADI commits an offence under subsection 13A(4) of the Banking Act unless it holds sufficient assets to cover all of its deposit liabilities.

Risks of hybrid securities Hybrid securities often have very complex features and the risks they can pose are often poorly understood by investors.68 In Senate Estimates on 26 October 2017, ASIC Chairman Greg Medcraft warned about the risks of hybrid securities, stating:

The big issue with these securities is the idiosyncratic risk. Basically, they can be wiped out—there's no default; just through the stroke of a pen they can be written off. For retail investors in the tier 1 securities they're principally retail investors, some investing as little as $50,000. These are very worrying. They are banned in the United Kingdom for sale to retail. I am very concerned that people don't understand, when you get paid 400 basis points over the benchmark, that is extremely high risk, and I think that, because they are issued by banks, people feel that they are as safe as banks. Well, you are not paid 400 basis points for not taking risks, and I do think this is, frankly, a ticking time bomb.

69

According to ASIC’s 2013 review of the hybrid securities market, the majority of sales in the primary market are to retail investors including two-thirds to self-managed superannuation funds. ASIC found that despite their warnings about the risks, hybrids are popular with retail investors because they offer relatively high returns, they

64. Banking Act, subsection 12(1). 65. G Turner, ‘Depositor protection in Australia’, Reserve Bank of Australia Bulletin, December Quarter, 2011, p. 51. 66. Ibid.

67. Ibid., p. 48. 68. ASIC, Hybrid securities, op. cit. 69. Senate Economics Legislation Committee, Official committee Hansard, op. cit., p. 30.

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are issued by major banks and other corporates who are generally seen as trusted brands and they have been promoted by brokers and financial advisers.70

In its latest Corporate Plan, ASIC stated that it will commence a new project in 2017-18 examining the selling and distribution practices of market intermediaries in relation to hybrids and to improve investor understanding of the risks of trading hybrids. 71

The UK has banned the sale of certain hybrids called ‘contingent convertible notes’ (or ‘CoCos’) to retail investors. In August 2014, the United Kingdom’s Financial Conduct Authority (FCA) issued ‘temporary product intervention rules’ which imposed restrictions on the distribution of CoCos to retail customers.72 The FCA made these restrictions permanent in June 2015.73 In issuing the restriction the FCA stated its concerns that ‘these securities are hard for investors to value and that their features may not fit naturally with the needs of ordinary retail investors’.74

Directions power—early intervention Each of the entities that APRA regulates is subject to APRA’s power to make binding directions. This power is a fundamental legislative tool for the enforcement of prudential supervision requirements and the implementation of financial crisis management. The directions power can be used in several ways including:

• enforcing prudential requirements where a regulated entity has failed to comply

• as an early intervention tool to enable APRA to manage problems affecting ADIs and insurers before they cause failure or systemic problems and

• as a means of limiting further deterioration in a period of emerging stress.75

Schedule 1 to the Bill:

1. expands the directions power in the Banking Act

2. ensures that a recapitalisation direction applies to a NOHC or NOHC subsidiary as well as to an ADI and

3. provides that certain directions are subject to secrecy and disclosure conditions.

The secrecy and strict disclosure conditions reflect the fact that in certain circumstances it may be appropriate to keep the giving of a direction confidential for a limited period in order to protect depositors/policyholders or to promote financial system stability in Australia.76

Expanding the directions power Existing section 11CA of the Banking Act empowers APRA to give directions to an ADI or an authorised NOHC where APRA has reason to believe certain matters—and details the sorts of directions it may give in that case. Subsection 11CA(1) sets out triggers for APRA to give directions based on the behaviour of the body corporate itself, while subsection 11CA(1AA) sets out triggers based on the behaviour of subsidiaries of the body corporate.

Item 34 of Schedule 1 to the Bill repeals subsection 11CA(1AA) and inserts proposed subsections 11CA(1AA)- (1AE) into the Banking Act. Proposed subsection 11CA(1AA) significantly expands the list of matters which might act as a trigger for APRA to issue a direction to a body corporate based on the behaviour of one of its subsidiaries, such that the triggers will largely mirror those in subsection 11CA(1). However, proposed subsection 11CA(1AB) qualifies APRA’s power in that APRA can only issue a direction to an ADI or authorised NOHC in response to certain triggers under subsection 11CA(1AA) if it is reasonably necessary for one or more prudential matters relating to the body corporate. The relevant triggers are:

70. ASIC, Hybrid securities, op. cit., p. 11. 71. Senate Economics Legislation Committee, Official committee Hansard, op. cit; ASIC, ASIC’s Corporate Plan 2017-18 to 2020-21, op. cit., p.29. 72. Financial Conduct Authority (FCA), Restrictions in relation to the retail distribution of contingent convertible instruments, FCA, August 2014, p. 3.

73. FCA, Restrictions on the retail distribution of regulatory capital instruments, FCA, June 2015. 74. Ibid., p. 7. 75. The Treasury, Strengthening APRA's crisis management powers, op. cit., p. 22 76. See Explanatory Memorandum, Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017, p. 83,

paragraphs 3.81-3.82.

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• a subsidiary of the body corporate has contravened—or is likely to contravene—a provision of the Banking Act, a prudential requirement, regulation or a prudential standard or the Financial Sector (Collection of Data) Act77

• a subsidiary of the body corporate is, or is about to become, unable to meet the subsidiary’s liabilities78

• there is, or there might be, a material risk to the security of the assets of a subsidiary of the body corporate79

• there has been, or there might be, a material deterioration in the financial condition of a subsidiary of the body corporate80 or

• a subsidiary of the body corporate is conducting the subsidiary’s affairs in an improper or financially unsound way or in a way that may cause it to be unable to continue to supply services to an ADI.81

Existing subsection 11CA(2) of the Banking Act lists the types of directions that APRA may give. Item 37 of the Bill repeals and replaces paragraph 11CA(2)(p) and inserts proposed paragraphs 11CA(2)(p)-(r) so that APRA may give directions to a body corporate to do, or to cause a body corporate that is its subsidiary to do, the following:

• to make changes to the body corporate’s systems, business practices or operations82

• to reconstruct, amalgamate or otherwise alter all or part of the business, structure or organisation of the body corporate or the group constituted by the body corporate and its subsidiaries83

• to do, or to refrain from doing, anything else in relation to the affairs of the body corporate.84

Recapitalisation directions Subdivision AA of Division 2 of Part II of the Banking Act applies to an ADI that is a company, registered under the Corporations Act that has a share capital but does not have a Banking Act statutory manager.85 The Subdivision applies to the NOHC/NOHC subsidiary in the same way that it does to an ADI if APRA has given a recapitalisation direction to an ADI (the primary recapitalisation direction) and the ADI is a subsidiary of a NOHC/NOHC subsidiary that is registered under the Corporations Act, has a share capital and is not itself under the control of a Banking Act statutory manager.86

Within Subdivision AA, subsection 13E(1) empowers APRA to give an ADI a direction (called a recapitalisation direction) that requires the ADI to increase the ADI’s level of capital to the level specified in the direction in specified circumstances. Item 91 of Schedule 1 to the Bill inserts proposed subsection 13E(1B) into the Banking Act so that APRA may also give the NOHC/NOHC subsidiary a direction (also a recapitalisation direction) that requires the NOHC/NOHC subsidiary to do anything that is specified in the direction.

The direction has effect until APRA revokes it.87

Existing subsection 13F(1) of the Banking Act provides that a recapitalisation direction may direct the ADI to issue shares, or rights to acquire shares, in the ADI or to issue other capital instruments of a kind specified in the direction.

77. Banking Act, proposed paragraph 11CA(1AA)(a)-(c). Item 42 of Schedule 1 to the Bill repeals and replaces subsection 11CA(5A) so that, amongst other things, decisions under these paragraphs are subject to Part VI of the Banking Act which provides for the reconsideration and review of decisions. 78. Banking Act, proposed paragraph 11CA(1AA)(e). 79. Banking Act, proposed paragraph 11CA(1AA)(f). 80. Banking Act, proposed paragraph 11CA(1AA)(g). 81. Banking Act, proposed paragraph 11CA(1AA)(h) and (k). 82. Banking Act, proposed paragraph 11CA(2)(p). 83. Banking Act, proposed paragraph 11CA(2)(q). 84. Banking Act, proposed paragraph 11CA(2)(r). 85. Banking Act, proposed subsection 13D(1). This reflects current section 13D, except for a change in terminology from ‘ADI statutory manager’

to ‘Banking Act statutory manager’. 86. Banking Act, proposed subsections 13D(2)-(4). 87. Banking Act, proposed subsections 13E(7) inserted by item 92 of Schedule 1 to the Bill.

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Item 93 of Schedule 1 to the Bill inserts proposed subsections 13F(1A)-(1C) into the Banking Act. The new subsections provide that a recapitalisation direction to a NOHC/NOHC subsidiary may direct the NOHC/NOHC subsidiary to do any of the following:

• issue shares, or rights to acquire shares, in the NOHC/NOHC subsidiary or other capital instruments in the NOHC/NOHC subsidiary

• acquire shares, or rights to acquire shares, in an ADI or other capital instruments in the ADI

• acquire shares, or rights to acquire shares, in a specified body corporate or other capital instruments in a specified body corporate.88

Existing section 13N of the Banking Act provides that a recapitalisation direction is not grounds for the denial of obligations to an ADI under a contract. Item 102 of Schedule 1 to the Bill repeals and replaces section 13N so that the provision applies to a body corporate that is party to a contract—rather than an ADI. The amended section 13N makes clear that the mere fact of the body corporate being subject to a recapitalisation direction or of another member of a group of bodies corporate being subject to a recapitalisation direction does not allow the contract, or a party to the contract (other than the body corporate), to deny any obligation under the contract, accelerate any debt under the contract, close out any transaction relating to the contract or enforce any security under the contract.

Importantly under section 14AA of the Banking Act, the statutory manager of an ADI also has powers to facilitate recapitalisation. (See discussion about the powers and functions of a Banking Act statutory manager below.)

Secrecy provisions Item 48 of Schedule 1 to the Bill repeals existing section 11CF of the Banking Act which provides a cross-reference to the secrecy requirements in Part 6 of the APRA Act.89

Instead, item 56 of Schedule 1 to the Bill inserts proposed Subdivision D—Secrecy and disclosure provisions relating to directions into Division 1BA of Part II of the Banking Act. Essentially the new subdivision applies to an entity to which APRA has given a direction (known as a directed entity).

First, APRA may determine, in writing, that the direction is subject to the secrecy provisions if APRA considers that the determination is necessary to protect the depositors of an ADI or to promote the stability of the financial system in Australia.90 In that case, APRA must give a copy of the determination to the directed entity as soon as practicable after making it.91

Second, the Bill provides that a person is covered by proposed section 11CI of the Banking Act if the person is:

• the directed entity

• an officer, employee or contractor of the directed entity at a time on or after APRA gave the directed entity the direction or

• any other person who, because of his or her employment, or in the course of that employment, has acquired information that reveals the fact that the direction was made.92

A person who is, or has been, covered by section 11CI commits an offence where a directed entity has been given a direction that is covered by a secrecy determination and the person discloses information which reveals the fact that the direction was made. The maximum penalty is imprisonment for two years.93 However, the offence will not arise if disclosure is authorised under another section of the Banking Act94 or the disclosure is required by an order or direction of a court or tribunal.95 The person who is being prosecuted will bear an

88. Banking Act, proposed subsection 13F(1A). 89. The reference is erroneous because Part 6 of the APRA Act does not operate to impose secrecy on regulated entities or their employees, officers or contractors. Instead it only applies to APRA staff. 90. Banking Act, proposed subsection 11CH(2). Proposed subsection 11CH(4) provides that the determination is not legislative instrument. 91. Banking Act, proposed subsection 11CH(3). 92. Banking Act, proposed subsection 11CI(2). 93. Banking Act, proposed subsection 11CI(1). 94. Those sections are section 11CJ, 11CK, 11CL, 11CM, 11CN or 11CO. 95. Banking Act, proposed subsection 11CI(3).

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evidential burden in relation to these matters, which means that he or she must adduce or point to evidence that suggests a reasonable possibility that the exception applies.96 If the person discharges this evidential burden, the prosecution must then discharge its legal burden to disprove the relevant matter beyond reasonable doubt.97

Protection from liability In addition, the Bill provides that a person is not liable in an action, suit or proceeding (whether criminal or civil) in relation to anything done, or omitted to be done, in good faith by the person if it is done for the purposes of complying with a direction given by APRA to a body corporate or in complying with a direction under proposed section 11CI (secrecy). This protection extends to an officer or senior manager of the body corporate, an employee or agent of the body corporate, and to the body corporate itself or a member of a relevant group of bodies corporate of which the body corporate is also a member.98

Scrutiny of Bills Committee The Scrutiny of Bills Committee commented on this provision and the equivalent provision for both the Insurance Act99 and the Life Insurance Act.100 Of particular concern to the Scrutiny of Bills Committee was the exception to the offence provision which, as set out above, imposes an evidential burden on the defendant. The Committee explained its concerns as follows:

Subsection 13.3(3) of the Criminal Code Act 1995 provides that a defendant who wishes to rely on any exception, exemption, excuse, qualification or justification bears an evidential burden in relation to that matter.

At common law, it is ordinarily the duty of the prosecution to prove all elements of an offence. This is an important aspect of the right to be presumed innocent until proven guilty. Provisions that reverse the burden of proof and require a defendant to disprove, or raise evidence to disprove, one or more elements of an offence, interferes with this common law right.

While in this instance the defendant bears an evidential burden (requiring the defendant to raise evidence about the matter), rather than a legal burden (requiring the defendant to positively prove the matter), the committee expects any such reversal of the evidential burden of proof to be justified.

In this instance, the explanatory memorandum states that the evidentiary burden rests on the person bound by the secrecy provision “because they are best positioned to provide the evidence as it is within their knowledge”… The committee notes that the [Guide to Framing Commonwealth Offences, Infringement Notices and Enforcement Powers

101 ] requires more than just the defendant knowing that a certain fact exists, it must be a matter that is peculiarly within their knowledge. As such, it is not clear to the committee that matters such as whether the disclosure has been permitted by APRA, authorised by relevant legislative provisions or required by an order or direction of a court or tribunal, would be matters peculiarly within the defendant's knowledge. These matters appear to be matters more appropriate to be included as an element of the offence.

102

The Treasurer responded to the Committee’s request for further explanation stating:

[the] proposed sections … set out secrecy provisions which the Australian Prudential Regulation Authority (APRA) may apply to ensure that details of a direction given by APRA to an authorised deposit-taking institution (ADI) or insurer or related entities are not disclosed. While most directions will properly be publically available, there are

96. See section 13.3 of the Criminal Code Act 1995. 97. Subsection 13.1(2) of the Criminal Code. 98. Banking Act, proposed section 70AA inserted by item 252 of Schedule 1 to the Bill. 99. Insurance Act, proposed section 109A inserted by item 135 of Schedule 2 to the Bill. 100. Life Insurance Act, proposed section 231A inserted by item 102 of Schedule 3 to the Bill. 101. Attorney-General’s Department, A guide to framing Commonwealth offences, infringement notices and enforcement powers, [Attorney-

General’s Department], [Canberra], September 2011. 102. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 13, 2017, 15 November 2017, p. 29.

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limited circumstances where a period of confidentiality is necessary to ensure panic does not develop in financial markets as a consequence of precipitously announced resolution actions. 103

The Treasurer went on to explain the defences available and that the defendant bears an evidential burden in relation to the defences because ‘the matters listed as defences would normally be expected to be peculiarly within the knowledge of the defendant’.104

In response to this explanation, the Scrutiny of Bills Committee noted the Guide to framing Commonwealth offences provides that a matter should only be included in an offence-specific defence where:

• it is peculiarly within the knowledge of the defendant and

• it would be significantly more difficult and costly for the prosecution to disprove than for the defendant to establish the matter.105

The Scrutiny of Bills Committee was not satisfied that the defences named in the Bill met the test set out above. The Committee requested that the key information provided by the Minister be included in the Explanatory Memorandum to the Bill.106

Position of stakeholders The Australian Bankers Association (ABA) raised specific concerns that a direction made by APRA may be inconsistent with disclosure requirements under foreign laws or listing rules of foreign securities exchanges.107 The ABA requested that the Committee recommend that the APRA be required to have regard to the obligations imposed on an ADI or NOHC under any applicable laws, including foreign laws before making a secrecy order.

Further, the ABA has asked that the Committee consider recommending that an exception to the secrecy obligations be introduced that allows for disclosure of information by a person subject to a secrecy determination to other officers in the institution as reasonably necessary.

Permitted disclosures Schedule 1 to the Bill provides that some disclosures relating to directions covered by a secrecy determination are permitted.

First, a person may disclose information that reveals the fact that the direction was made, to the extent that the information has already been lawfully made available to the public.108

Second, the Bill empowers APRA to make a determination in writing that a specified person may disclose specified information in relation a specified direction or a specified class of directions.109 In addition, APRA may, by legislative instrument allow a specified class of persons to disclose specified kinds of information in relation to the direction or any kind of information in relation to the direction.110

In either of those circumstances, APRA may include conditions in relation to the kind of entities to which the disclosure may be made, the manner in which the disclosure is to be made and any other matter that APRA considers appropriate.111

Third, a person covered by section 11CI may disclose information that reveals the fact that the direction was made provided that the disclosure is to the person’s legal representative and the purpose of the person making the disclosure is for the legal representative to provide legal advice, or another legal service, in relation to the direction.112

103. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 15, 2017, 6 December 2017, pp. 62-3. 104. Ibid., p. 63. 105. Attorney-General’s Department, A guide to framing Commonwealth offences, infringement notices and enforcement powers, op. cit., p. 50. 106. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 15, 2017, op. cit., p. 67. 107. Australian Bankers Association, Submission to the Senate Standing Committee on Economics, Inquiry into the Financial Sector Legislation

Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 [Provisions], 18 December 2017, p. 2. 108. Banking Act, proposed section 11CJ. 109. Banking Act, proposed subsection 11CK(2). 110. Banking Act, proposed subsection 11CK(5). 111. Banking Act, proposed subsection 11CK(6). 112. Banking Act, proposed section 11CL.

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Fourth, a person covered by section 11CI in relation to a direction may disclose information that reveals the fact that the direction was made if:

• the person is an APRA member,113 an APRA staff member,114 a Commonwealth officer who is covered by paragraph 56(1)(c) of the definition of officer in the APRA Act115

• the information is protected information or is contained in a protected document116 and

• the disclosure is in accordance with subsection 56(3), (4), (5), (5AA), (6), (6A), (7), (7A), (7B) or (7C) of the APRA Act.117

Additionally a person covered by section 11CI in relation to a direction may disclose information that reveals the fact that the direction was made if:

• the disclosure is made in circumstances (if any) set out in the regulations118 or

• another person covered by section 11CI disclosed that information to the relevant person for an approved purpose and the disclosure by the relevant person is for the same purpose.119

Statutory management It is important that APRA has effective powers to intervene when regulated financial institutions are at risk of experiencing financial difficulties that threaten their ongoing viability, and to ensure the effective resolution of the situation in a manner that maintains the stability of the financial system and protects depositors. The statutory management regime provides:

… a flexible mechanism for dealing with a financial institution in acute distress and where APRA does not have confidence that the board and management of the ADI or insurer is capable of resolving the distress satisfactorily or where the board and management are mismanaging the entity. Statutory and judicial management provides a tool through which a range of potential resolution actions may be implemented. For example, statutory or judicial management enables the implementation of a resolution that preserves the core business and functionality, and the economic value, of a regulated entity with a view to the entity’s business continuing as a going concern.

120

Schedule 1 to the Bill:

1. expands the list of circumstances in which APRA may investigate or take control of an ADI’s business in order to protect depositors

2. substitutes existing references to an ADI statutory manager with references to a Banking Act statutory manager

3. sets the circumstances in which control will terminate and

4. details the functions and powers of the statutory manager.

Exercise of control by APRA or statutory manager Under existing subsection 13A(1) of the Banking Act, APRA may investigate the affairs of an ADI, appoint a person to investigate the affairs of an ADI, take control of the ADI’s business or appoint an administrator to take control of the ADI’s business in specified circumstances which are listed in paragraphs 13A(1)(a)-(c). Subsection 13A(1) of the Banking Act provides that an ADI statutory manager—being either APRA or an administrator of an ADI’s business appointed by APRA—may take control of a regulated entity’s business. The

113. Subsection 3(1) of the APRA Act defines the term APRA member as a member of APRA, including the Chair and Deputy Chair. 114. Subsection 3(1) of the APRA Act defines the term APRA staff member as a person appointed by APRA under section 45 of the APRA Act, a person assisting APRA under section 46 of the APRA Act or a person engaged by APRA under section 47 of the APRA Act. 115. That is, any other person who, because of his or her employment, or in the course of that employment has acquired protected information or

has had access to protected documents—other than an employee of the body to which the information or document relates. 116. Subsection 56(1) of the APRA Act defines the terms protected information and protected document. 117. Banking Act, proposed subsection 11CM(1). 118. Banking Act, proposed section 11CN. 119. Banking Act, proposed section 11CO. 120. The Treasury, Strengthening APRA’s crisis management powers, op. cit., p. 56.

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Bill substitutes existing references to an ADI statutory manager with references to a Banking Act statutory manager.121

Item 64 inserts proposed paragraphs 13A(1)(d) and (e) to expand the list of circumstances in which APRA may exercise the power to investigate or take control of an ADI to include:

• that an external administrator has been appointed to a holding company of the ADI and APRA considers that the appointment poses a significant threat to the operation or soundness of the ADI, the interests of its depositors or the stability of the financial system in Australia

• if the ADI is a foreign ADI—that an application for the appointment of an external administrator of the foreign ADI, or for a similar procedure in respect of the foreign ADI, has been made in a foreign country or that an external administrator has been appointed to the foreign ADI (or a similar appointment has been made) in a foreign country.

The provisions are consistent with APRA’s expanded authorisation powers as discussed above.

Item 65 of Schedule 1 to the Bill repeals subsection 13A(2) and inserts proposed subsections 13A(1B)-(1F) and proposed subsections 13A(2) and (2A). The operation of new provisions is explained below.

First APRA may take action in relation to a body corporate (called the target body corporate). Those actions are either taking control of the business of the target body corporate or appointing an administrator to take control of the business of the target body corporate.122

Second the target body corporate must be:

• an authorised NOHC of an ADI, a subsidiary of an authorised NOHC of an ADI or a subsidiary of an ADI

• incorporated in Australia and

• not a body corporate of a kind specified in regulations (if any).123

Third, the conditions in proposed subsections 13A(1D), (1E) or (1F), as set out below, must be satisfied.124

The condition for proposed subsection 13A(1D) is satisfied if:

• either a Banking Act statutory manager has taken control of the relevant ADI—or APRA intends that a Banking Act statutory manager will take control for any of the reasons specified in paragraphs 13A(1)(a)-(e) and

• APRA considers that the target body corporate provides services that are, or conducts business that is, essential to the capacity of the relevant ADI to maintain its operations.

The condition for proposed subsection 13A(1E) is satisfied if:

• either a Banking Act statutory manager has taken control of the relevant ADI—or APRA intends that a Banking Act statutory manager will take control for any of the reasons specified in paragraphs 13A(1)(a)-(e) and

• APRA considers that it is necessary for a Banking Act statutory manager to take control of the target body corporate, in order to facilitate the resolution of the relevant ADI, an authorised NOHC of the relevant ADI, a relevant group of bodies corporate of which the relevant ADI is a member or a particular member or particular members of such a group.

The condition for proposed subsection 13A(1F) is satisfied if:

• there is an external administrator of the target body corporate, or APRA considers that, in the absence of external support the target body corporate may become unable to meet its obligations or may suspend payment and

121. For instance, items 72, 75-77, 111-112, 114-117, 119-121, 123 and 125 of Schedule 1 to the Bill. 122. Banking Act, proposed subsection 13A(1C). 123. Banking Act, proposed paragraphs 13A(1B)(a), (c) and (d). 124. Banking Act, proposed paragraph 13A(1B)(b).

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• APRA considers that it is necessary to take action under subsection 13A(1C) in order to enable the relevant ADI to maintain its operations, or to facilitate the resolution of the relevant ADI, an authorised NOHC of the relevant ADI, a relevant group of bodies corporate of which the relevant ADI is a member or a particular member or particular members of such a group.

Proposed subsection 13A(2A) provides that more than one Banking Act statutory manager may be appointed.

Termination of control The current formulation of section 13C of the Banking Act can be read as meaning that, in the absence of insolvency, APRA’s control of an ADI or statutory management can only be terminated where depositors have been repaid or will be repaid. The Banking Act does not provide the flexibility for APRA to terminate its control of an ADI or to terminate statutory management in a wider range of circumstances—in particular where the resolution of the ADI’s affairs has been completed and APRA’s control or statutory management is no longer necessary.125

That being the case, item 79 of Schedule 1 to the Bill repeals and replaces subsection 13C(1) of the Banking Act so that if APRA assumes control of a body corporate’s business or appoints an administrator of a body corporate’s business, either APRA or the administrator must have control of the body corporate’s business until APRA considers that it is no longer necessary or APRA has applied for the body corporate to be wound up. This is called an ultimate termination of control.

Statutory manager’s powers and functions As stated above the Banking Act makes reference to an ADI statutory manager. Under the Bill, a reference to an ADI statutory manager becomes a reference to a Banking Act statutory manager and picks up the functions and powers set out in existing subsection 14A(1) of the Banking Act—being the powers and functions of the members of the board of directors of the ADI (collectively and individually), including the board’s powers of delegation. Item 107 of Schedule 1 to the Bill amends subsection 14A(1) so that a Banking Act statutory manager of a body corporate has the powers and functions of the members of the board of directors of the body corporate.126

Safeguards Item 131 of Schedule 1 to the Bill inserts proposed section 14AAA into the Banking Act to prevent a Banking Act statutory manager of a body corporate (the body corporate under management) from performing a function or exercising a power under section 14A where the performance or exercise is not for the purposes of subsection 14AA(1) of the Banking Act127 or Part 3 or 4 of the FSTR Act128 and either or both of the following apply:

• first: the body corporate under management is not an ADI and the performance or the exercise would result in the provision of services by the body corporate under management to a related body corporate (or vice versa) or the transfer of assets between the body corporate under management and another body corporate (otherwise than in the ordinary course of business) for other than fair value, where the performance or the exercise is not required or permitted by a binding arrangement that was in existence immediately before the Banking Act statutory manager started to be in control of the business,129

• second: where the body corporate under management is an authorised NOHC of an ADI, the performance or the exercise requires using funds of the body corporate or a subsidiary of the body corporate to increase the level of capital of the ADI to a specified level and the shareholders of the body corporate have not agreed, by ordinary resolution, to that use of the funds.130

125. The Treasury, Strengthening APRA’s crisis management powers, op. cit., p. 67. 126. Items 165-173 of Schedule 1 to the Bill amend section 15 of the Banking Act which sets out the effect on directors of an ADI statutory manager taking control of an ADI’s business. 127. Subsection 14AA(1) of the Banking Act as amended by items 133 to 135 of Schedule 1 to the Bill permits a Banking Act statutory manager of a

body corporate to do a number of acts in relation to the company’s share capital (such as issue, cancel or sell shares) on terms determined by the statutory manager. 128. Part 3 of the FSTR Act contains voluntary transfer of business provisions. Part 4 contains compulsory transfer provisions. 129. Banking Act, proposed subsection 14AAA(2). 130. Banking Act, proposed subsection 14AAA(3).

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APRA-appointed administrator As stated above the Banking Act statutory manager may be APRA itself or an administrator appointed by APRA.

Schedule 1 to the Bill:

1. updates the nature of the recommendations that the administrator of an ADI may give APRA

2. includes immunities for a Banking Act statutory manager from civil or criminal liability and

3. allows APRA to terminate the appointment of an administrator and, if necessary, appoint another.

Recommendations Existing subsection 14B(1) of the Banking Act empowers an administrator to may make certain recommendations to APRA, by instrument in writing given to APRA. Item 146 repeals and replaces subsection 14B(1) to expand the list of recommendations to include circumstances where the body corporate is an authorised NOHC. In that case a recommendation may be made that APRA revoke the authorised NOHC’s authority to carry on a banking business under subsection 11AA(2).

Immunity Statutory managers and judicial managers are charged with the responsibility to protect depositor and policyholder interests and to promote financial system stability and, in accordance with this twin purpose, may be required to take actions that have the potential to adversely affect directors, shareholders and certain classes of creditors. It is therefore conceivable that adversely affected stakeholders may subsequently seek to recover any loss suffered by a legal action against the statutory manager or judicial manager personally.

Section 14C of the Banking Act provides that a statutory manager will only be liable for loss that is incurred because of any fraud, dishonesty, negligence or wilful failure to comply with the provisions of the Banking Act. In comparison, section 62ZM of the Insurance Act and section 179 of the Life Insurance Act provide greater protection than is provided by the Banking Act in the following respects:

• under the insurance legislation, immunity is not available where the judicial manager fails to act ‘in good faith’. By contrast, immunity is not available under the Banking Act where the statutory manager acts in a ‘negligent’ fashion. In most situations, it will be easier for a claimant to establish negligence than a lack of good faith and

• the insurance legislation is expressed to apply generally to ‘any liability’. By contrast, the Banking Act refers to ‘a loss’.

In order to impose an equivalent standard in the Banking Act, item 149 of Schedule 1 to the Bill repeals existing subsections 14C(1)-(4) of the Banking Act. Proposed subsections 14C(1)-(3) operate so that a Banking Act statutory manager, or a person acting on behalf of a Banking Act statutory manager, is not subject to any liability (whether civil or criminal) in respect of anything done, or omitted to be done, in the exercise or performance, or the purported exercise or performance, of powers, functions or duties conferred or imposed on the Banking Act statutory manager by or under the Banking Act. There is an exception to this general rule—that is, the immunity will not apply to an act or omission in bad faith.131

Interaction with the Corporations Act Within Chapter 5 (which deals with external administration), section 588G of the Corporations Act provides that a director has a duty to prevent insolvent trading by a company. The Bill provides that a Banking Act statutory manager is not liable under that section for anything done, or omitted to be done, in the exercise or performance, or the purported exercise or performance, of powers, functions or duties conferred or imposed on the Banking Act statutory manager by or under the Banking Act.132

Chapter 5 of the Corporations Act provides for the recovery of property or compensation for the benefit of creditors of an insolvent company. Section 588FE of the Corporations Act sets out various circumstances in which a transaction that has been entered into by an insolvent company is voidable. These are known as ‘clawback’ provisions.

131. Banking Act, proposed subsections 14C(1) and (2). 132. Banking Act, proposed subsection 14C(3).

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The Bill provides that transactions entered into by a Banking Act statutory manager are not voidable under section 588FE of the Corporations Act merely because the transaction is:

• an uncommercial transaction (as defined in section 588FB of the Corporations Act) of the body corporate

• an unfair preference (as defined in section 588FA of the Corporations Act) given by the body corporate to a creditor of the company or

• an insolvent transaction (as defined by section 588FC of the Corporations Act) of the body corporate.133

Termination of appointment Currently section 14E of the Banking Act authorises APRA to terminate the appointment of an administrator. Item 162 repeals and replaces subsections 14E(1) and (2) so that APRA may terminate the appointment of an administrator of a body corporate’s business and either appoint another person as administrator of the body corporate’s business or take control of the body corporate’s business in the following circumstances:

• the administrator contravenes a requirement of Division 2 of Part II of the Banking Act or

• APRA considers such action necessary to facilitate the resolution of the body corporate, a relevant group of bodies corporate of which the body corporate is a member, or another member of such a group, to protect the interests of depositors of the ADI or to promote financial system stability in Australia.134

The terms and conditions of an administrator’s appointment may provide for termination in circumstances in addition to those set out above.135

Moratorium When a statutory manager is appointed to an ADI he, or she, needs time to assess the nature of the financial damage affecting the institution and will, along with APRA and the Government, be required to determine an appropriate resolution. The statutory manager also needs to have access to the institution’s resources for the purposes of the administration.

The moratorium provisions temporarily prevent creditors and others from taking litigious and enforcement actions that have the potential to distract from or hamper the diagnosis and resolution of financial distress.

Currently section 15B of the Banking Act provides that a person cannot begin or continue a proceeding in a court against an ADI while an ADI statutory manager is in control of the ADI’s business unless the court grants leave on the ground that the person would be caused hardship if leave were not granted or APRA consents to the proceedings beginning or continuing. This is known as a moratorium provision. Item 190 repeals section 15B and inserts proposed sections 15B-15BE into the Banking Act which detail six separate circumstances in which a moratorium applies.

First, where a Banking Act statutory manager is in control of a body corporate’s business, a person cannot begin or continue any of the following proceedings against the body corporate in a court or tribunal:136

• a proceeding against the body corporate, including a cross-claim or third party claim

• a proceeding in relation to property of the body corporate

• a proceeding to enforce any security (including a mortgage or charge) granted by the body corporate, or by a related body corporate of the body corporate, over any property that the body corporate owns, uses, possesses, occupies or in which the body corporate otherwise has an interest.137

This general rule does not apply if the court or tribunal grants leave for the proceedings to be begun or continued (subject to any relevant terms) on the ground that the person would be caused hardship if leave were not granted or if APRA or the Banking Act statutory manager consents to the proceedings. 138.

133. Banking Act, proposed section 14CA inserted by item 151 of Schedule 1 to the Bill. 134. Banking Act, proposed subsection 14E(1). 135. Banking Act, proposed subsection 14E(2). 136. For the purposes of this section, a tribunal includes a reference to an industrial tribunal and an arbitral tribunal. Banking Act, proposed

subsection 15B(10). 137. Banking Act, proposed subsection 15B(8).

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Second, no enforcement process in relation to property of a body corporate can be begun or proceeded with if a Banking Act statutory manager is in control of the body corporate’s business—unless the Federal Court of Australia grants leave or if APRA or the Banking Act statutory manager consents to the proceedings.139

Third, a person must not dispose of property if the property is owned by another person, being a body corporate over whose business a Banking Act statutory manager has control.140 The exception to this general rule is where either APRA or the Banking Act statutory manager consents to the disposal. 141

Fourth, section 440B of the Corporations Act, which restricts the exercise of third party property rights (including, for example, taking possession of the property or otherwise seeking to recover it) applies during a period in which a Banking Act statutory manager is in control of a body corporate’s business in the same way it applies during the administration of a company.142

Fifth, if a Banking Act statutory manager who is in control of a body corporate’s business requests a person or authority (the supplier) to supply an essential service to the body corporate in Australia and the body corporate owes an amount to the supplier in respect of the supply of the essential service143 before the day on which the Banking Act statutory manager took control of the body corporate’s business the supplier must not refuse to comply with the request for the reason only that the amount is owing or make it a condition of the supply of the essential service pursuant to the request that the amount is to be paid.144

Sixth, a body corporate need not hold its annual general meeting within the time frames specified in sections 250N and 601BR of the Corporations Act if a Banking Act statutory manager is in control of the body corporate’s business at the end of that period.145

Scrutiny of Bills Committee The Scrutiny of Bills Committee commented in relation to the first of these measures.146 Whilst the Committee noted the rationale for the measure as set out in the Explanatory Memorandum it questioned ‘whether the rights of creditors and third parties would be adversely affected by these provisions even once a statutory manager is no longer in control of the body corporate’.147

In particular, the Committee was uncertain whether a person could lose their right to bring an action against a body corporate because of statutory time limits having passed while the body corporate's business was under the control of a statutory manager. That being the case, the Minister was requested to provide further information.

In response the Treasurer advised that the relevant provisions ‘are moratorium provisions only and temporarily suspend or stay the right to bring or continue proceedings rather than remove the cause of action’ and that ‘there are checks and balances that mitigate against the risk of these provisions applying in a harsh or unjust way’.148

138. Banking Act, proposed subsections 15B(2) and (5). 139. Banking Act, proposed subsections 15BA(1), (2) and (5). 140. Banking Act, proposed subsection 15BB(1). 141. Banking Act, proposed subsection 15BB(2). 142. Banking Act, proposed subsection 15BC(1). 143. Section 600F of the Corporations Act provides that the term essential service means electricity, gas, water or a carriage services within the

meaning of the Telecommunications Act 1997. 144. Banking Act, proposed subsection 15BD(1). 145. Banking Act, proposed section 15BE. 146. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 13, 2017, op. cit., p. 30. Equivalent measures are Insurance Act, proposed

section 62P inserted by item 33 and proposed section 62ZOR inserted by item 58 in Schedule 2 to the Bill; and Life Insurance Act, proposed section 161 inserted by item 28 and proposed section 179AR inserted by item 52 in Schedule 3 to the Bill. 147. Ibid., p. 31. 148. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 15, 2017, op. cit., p. 69.

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Winding up an ADI Schedule 1 to the Bill:

1. allows APRA to apply to the Federal Court for an order that an ADI be wound up if APRA considers that the ADI is insolvent and could not be restored to solvency

2. sets out the circumstances in which protected account holders may access the financial claims scheme

3. provides that an ADI is to be wound up in accordance with the Corporations Act and

4. provides for the making of a transferred liabilities determination by APRA.

Application for winding up an ADI Currently, section 14F of the Banking Act empowers APRA to apply to the Federal Court of Australia for an order that an ADI be wound up if an ADI statutory manager is in control of the ADI’s business and APRA considers that the ADI is insolvent and could not be restored to solvency within a reasonable period. Item 163 of Schedule 1 to the Bill repeals this section. In its place item 212 inserts proposed section 16AAA into Division 2 of Part II of the Banking Act. The new section removes the requirement that an ADI statutory manager is in control of the ADI’s business before the winding up application is made. APRA must inform the Minister of the application as soon as possible. 149

No denial of obligations Existing section 15C of the Banking Act sets limits on the actions third parties can take in the event that a statutory manager is appointed to an ADI. Item 191 of Schedule 1 to the Bill repeals and replaces section 15C to expand the operation of the section to a party to a contract with a body corporate. Upon the appointment of a Banking Act statutory manager, the contract or another party to the contract (other than the body corporate) cannot:

• deny any obligations under that contract

• accelerate any debt under that contract

• close out any transaction relating to that contract or

• enforce any security under that contract.

These provisions are important because the appointment of a statutory manager to an ADI is likely to be an ‘event of default’ under many commercial contracts. This may have a number of consequences that are detrimental to the continuing operations of the ADI. That being the case, the provisions protect the financial position of the ADI and the interests of depositors until the statutory manager has had time to make an assessment as to an appropriate course of action.150

Access to the financial claims scheme

About the FCS The Financial Claims Scheme (FCS) was established by the Government in 2008.151 Section 16AD of the Banking Act:

• allows the Minister to make a declaration about an ADI that entitles account-holders to have access to the FCS, if APRA has applied to the Federal Court to have the ADI wound up and

• substitutes APRA for those account-holders as a creditor of the declared ADI to the extent of the entitlements.152

Item 213 of Schedule 1 to the Bill amends section 16AB of the Banking Act so that the Minister may make a declaration about an ADI if either APRA has applied for the ADI to be wound up or a Banking Act statutory

149. Banking Act, proposed section 16AAA(5). 150. The Treasury, Strengthening APRA’s crisis management powers, op. cit., p. 60. 151. K Rudd (Prime Minister), Global financial crisis, media release, 12 October 2008. 152. Banking Act, section 16AB.

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manager is in control of the ADI’s business. The declaration entitles account-holders who have certain protected accounts to access the financial claims scheme.153

An account-holder who has a protected account with a net credit balance with a declared ADI at the declaration time is entitled to be paid by APRA an amount equal to the sum of that balance and the interest (if any) accrued by, but not credited to, the account-holder before the declaration time—increased or decreased in accordance with the regulations to take account of clearance of transactions connected with the protected account.154

Section 7 of the Banking Regulation 2016 provides that the following are protected accounts:

call accounts cash management accounts

cheque accounts current accounts

debit card accounts farm management deposit accounts

pensioner deeming accounts personal basic accounts

retirement savings accounts savings accounts

term deposit accounts transactions accounts

trustee accounts mortgage offset accounts (whether a full or partial offset) that

are separate deposit accounts

The amount payable is capped at $250,000.155

Transferred liabilities determination Section 25 of FSTR Act empowers APRA to make a written determination that there is to be a compulsory total transfer or compulsory partial transfer of business from one ADI to another ADI in specified circumstances. In making the determination, APRA must consider the interests of depositors of the transferring body and determine that it is appropriate for the transfer to be made.

Item 215 of Schedule 1 to the Bill amends section 16AD of the Banking Act so that the Minister may declare that Subdivision C of Division 2AA of Part II of the Banking Act applies to an ADI if either APRA has applied for the ADI to be wound up or a Banking Act statutory manager is in control of the ADI’s business. Having done so, it is open to APRA to make a transferred liabilities determination provided that the following conditions are satisfied:

• APRA has made, or proposes to make a determination under section 25 of the FSTR Act

• the transfer of business will transfer the liabilities of the declared ADI in respect of every protected account kept by an account-holder with the ADI

• APRA is satisfied that it will be able to identify those protected accounts

• APRA made reasonable estimates of the total amount to which relevant account-holders will be entitled under the FCS (called the FCS amount), the total amount of the costs that would be incurred by APRA in relation to the exercise of its powers and the performance of its functions under Division 2AA (called the administration amount) and

• APRA considers that it is reasonable in the circumstances to make the determination.156

Under the Bill, APRA must make a transferred liabilities determination and issue a certificate of transfer under section 33 of the FSTR Act before the receiving body is entitled to be paid the amount specified in the determination.157

153. Banking Act, proposed section 16AD(1) inserted by item 215 in Schedule 1 to the Bill. 154. Banking Act, section 16AF. 155. Banking Regulation, section 11. 156. Banking Act, proposed subsection 16AIA(1) inserted by item 218 in Schedule 1 to the Bill. 157. Banking Act, proposed subsections 16AIC(1) and (2) inserted by item 218 in Schedule 1 to the Bill.

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Once that occurs:

• an account-holder’s entitlement to be paid an amount in respect of a protected account kept with the declared ADI is reduced to nil158 and

• the declared ADI is liable to pay to APRA an amount equal to the sum of the total payment amount specified in the determination as soon as the certificate of transfer comes into force.159

Winding up and foreign ADIs Currently subsection 11E(1) provides that Division 2 of Part II of the Banking Act (about protections for depositors) does not apply to foreign ADIs. Further, under existing subsection 11E(2), a foreign ADI commits an offence if it accepts a deposit from a person in Australia and, before doing so, does not inform the person in the approved manner and form that the deposit is not protected under Australian law.

Item 58 of Schedule 1 to the Bill repeals subsection 11E(1) and inserts proposed subsections 11E(1), 11E(1A) and 11E(1B) into the Banking Act to clarify that certain provisions do not apply in relation to the business of a foreign ADI (other than Australian business assets and liabilities) or to the management of a foreign ADI, to the extent that the management relates to such business of the foreign ADI.160 In support of this amendment item 59 of Schedule 1 to the Bill inserts the definition of Australian business assets and liabilities of a foreign ADI, being:

• the assets and liabilities of the foreign ADI in Australia

• any other assets and liabilities of the foreign ADI that are related to its operations in Australia and which are of a kind specified in regulations (if any).161

Item 60 of Schedule 1 to the Bill provides that APRA may apply to the Federal Court of Australia for an order that a foreign ADI be wound up if APRA considers that any of the following are satisfied:

• the foreign ADI is unable to meet its liabilities in Australia, or in one or more foreign countries, as and when they become due and payable

• an application for the appointment of an external administrator of the foreign ADI, or for a similar procedure in respect of the foreign ADI, has been made in a foreign country

• an external administrator has been appointed to the foreign ADI, or a similar appointment has been made in respect of the foreign ADI, in a foreign country.162

APRA must inform the Minister of the application as soon as possible.163 If the order is granted, the winding up of the foreign ADI is to be conducted in accordance with Part 5.7 of the Corporations Act.164

Amending the Insurance Act The purpose of the Bill is to amend the Industry Acts in order that they operate in an equivalent manner. That being the case, many of the amendments to the Insurance Act in Schedule 2 to the Bill are in the same form as those to the Banking Act.

For this reason, the amendments to the Insurance Act are not discussed in the same level of detail as for the Banking Act above.

Background Liability insurance protects the insured against the consequences of being legally liable for injury or damage to third parties. Such policies usually provide that the insured must take ‘all reasonable precautions’ to prevent the

158. Banking Act, proposed subsection 16AIC(3) inserted by item 218 in Schedule 1 to the Bill. 159. Banking Act, proposed subsections 16AIC(4) and (5) inserted by item 218 in Schedule 1 to the Bill. 160. Banking Act, proposed subsection 11E(1). The relevant provisions are sections 12, 13BA and 13C, and Subdivision B of Division 2 (statutory management), subsections 13A(1)-(2), to the extent that those subsections relate to statutory management and sections 62B, 62C, 62D and

62E (miscellaneous matters). 161. Banking Act, proposed subsection 11E(3). 162. Banking Act, proposed subsection 11EA(1). 163. Banking Act, proposed subsection 11EA(4). 164. Banking Act, proposed subsection 11EA(3).

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liability from arising. There are a number of types of liability insurance, including personal liability, public liability, professional indemnity, and product liability.165 One of the features of liability insurance is its 'long tail’. This means that there can be many years between an injury occurring and the time an insurer receives the notice of a claim.

The activities of general insurance companies can be divided into operating activities (that is, selling insurance) and investing activities. Revenues from operating activities include insurance premiums and reinsurance recoveries (that is, claims made by the insurance company on reinsurance contracts).166

Throughout most of the 1990s, the Australian general insurance industry made underwriting losses which were offset with investment income.167 The collapse of HIH Insurance Limited and associated companies in approximately March 2001 was significant because HIH was Australia's second largest insurance company and held a large share of the market for certain classes of liability insurance. That market share was won through aggressively offering lower premiums. In effect, HIH’s premiums were not sufficient to either cover claims made in the event of a catastrophic event or to generate sufficient investment income to cover the deficit. The collapse of HIH led to premium increases brought about by more disciplined underwriting. 168

According to the HIH Royal Commission:

… the deficiency of the group was estimated to be between $3.6 billion and $5.3 billion. If the ultimate shortfall is anywhere near the upper end of that range, the collapse of HIH will be the largest corporate failure Australia has endured to date. 169

Authorisation Section 12 of the Insurance Act requires a body corporate to apply in writing to APRA for authority to carry on an insurance business in Australia. Where the authority is granted, APRA must ensure that notice of the authority is published in the Gazette.170 APRA may impose conditions, or additional conditions, or vary or revoke existing conditions on the body corporate’s authority at any time. Those conditions must relate to prudential matters.171 The Bill repeals and replaces the definition of prudential matters in subsection 3(1) of the Insurance Act.172 The updated definition is in equivalent terms to the definition that is inserted into the Banking Act by Schedule 1 to the Bill.173

Consistent with the amendments to the Banking Act, Schedule 2 to the Bill amends the Insurance Act to strengthen the authorisation process for insurers in the following ways:

• amending existing section 15 of the Insurance Act so that the list of legal requirements with which an insurer must comply—or face the prospect that its authority will be revoked—is in equivalent terms to those in the Banking Act174

• amending the Insurance Act to extend APRA’s power to revoke an authority to a foreign corporation175

• empowering APRA to give a notice to a body corporate that is a holding company of a general insurer where the general insurer is not a subsidiary of an authorised NOHC, requiring either:

165. D Kehl, Liability insurance premium increases: causes and possible government responses, Current issues brief, 10, 2001-02, Parliamentary Library, Canberra, 19 March 2002, p. 1. 166. Reinsurance is a contract of insurance taken out by the original insurer (the reinsured) with another insurer (the reinsurer) to indemnify the reinsured against liability or payments under the original or underlying contract of insurance. Source: Butterworths Concise Australian Legal

Dictionary, 3rd edition, LexisNexis Butterworths, Australia, 2004, p.371. 167. Kehl, Liability insurance premium increases: causes and possible government responses, op. cit., p. 3. 168. T Sykes, ‘Getting tough on insurance: APRA rises as HIH falls’, The Australian Financial Review, 15 March 2001; J Breusch, ‘Risk remains after insurance crisis talks’, The Australian Financial Review, 19 March 2001; J Breusch, ‘Insurance hike hits professionals’, The Australian Financial

Review, 30 March 2001; J Breusch, ‘Life after the insurer’s death’, The Australian Financial Review, 17 April 2001. 169. J Owen, The Failure of HIH Insurance: a corporate collapse and its lessons, vol. 1, The Commission, Sydney, 2003. 170. Insurance Act, subsection 12(4). 171. Banking Act, section 13. 172. The updated definition is inserted by item 5 of Schedule 2 to the Bill. 173. See item 8 of Schedule 1 and discussion on page 9 of this Digest. 174. Insurance Act, proposed subparagraphs 15(1)(a)(iia) and (iii) inserted by item 10 of Schedule 2 to the Bill. 175. Insurance Act, proposed paragraph 15(1)(fa) inserted by item 11 of Schedule 2 to the Bill.

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- the body corporate to become an authorised NOHC of the general insurer or - that one of its subsidiaries becomes an authorised NOHC of the general insurer176 • expanding APRA’s power to require each subsidiary of a general insurer or of an authorised NOHC and each subsidiary of a general insurer or of an authorised NOHC included in a specified class of subsidiaries to satisfy

particular requirements in relation to prudential matters.177

Conversion and write-off provisions Item 17 of Schedule 2 to the Bill inserts proposed Division 2—Conversion and write-off provisions into Part IIIA of the Insurance Act.178 These provisions are in similar, but not equivalent terms, to those in the Banking Act with the differences relating to matters that are specific to the Insurance Act. Importantly, the conversion and write-off provisions apply to a general insurer, the holding company of a general insurer, a subsidiary or related subsidiary of a general insurer and any other entity which may be prescribed by the regulations. 179

Judicial management Part VB of the Insurance Act currently refers to judicial management, external administration and winding up. In particular Part VB empowers APRA to apply to the Federal Court for an order that a general insurer be placed under judicial management.180 Similarly, a general insurer may, of its own volition, apply to the Federal Court for an order that it be placed under judicial management—provided that it has given APRA one month’s notice of that intention. 181

In response to such an application, the Federal Court may order that a general insurer be placed under judicial management if it is satisfied of a number of matters that are listed in the Insurance Act.182 The Bill expands the matters about which the Court must be satisfied to include:

• an external administrator has been appointed to a holding company of the general insurer and the appointment poses a significant threat to the operation or soundness of the general insurer, the interests of policyholders of the general insurer or the stability of the financial system in Australia183

• if the general insurer is a foreign general insurer—an application for the appointment of an external administrator of the foreign general insurer, or for a similar procedure in respect of the foreign general insurer, has been made in a foreign country or

• if the general insurer is a foreign general insurer—an external administrator has been appointed to the foreign general insurer, or a similar appointment has been made in respect of the foreign general insurer, in a foreign country.

Moratorium Currently section 62P of the Insurance Act provides that a proceeding in a court against the general insurer or in relation to any of its property cannot be commenced or proceeded with except with the judicial manager’s written consent or with the leave of the Federal Court on any terms that the Court imposes. Item 33 of Schedule 2 to the Bill repeals section 62P and inserts proposed sections 62P-62PE into the Insurance Act to detail the circumstances in which a moratorium applies. These are in equivalent terms to those which are inserted into the Banking Act by item 190 of Schedule 1 and discussed at pages 24 to 25 of this Digest.

Appointment of judicial manager Currently, subsection 62R(1) of the Insurance Act provides that where the Federal Court orders the judicial management of a general insurer, it is the Court which must appoint the judicial manager. The Bill provides for the appointment of a substitute judicial manager or additional judicial managers should the need arise.184

176. Insurance Act, proposed section 23A inserted by item 14 of Schedule 2 to the Bill. 177. Insurance Act, proposed subparagraphs 32(3)(a)(v) and (vi) inserted by item 16 of Schedule 2 to the Bill. 178. Part IIIA of the Insurance Act deals with prudential supervision and monitoring of general insurers, authorised NOHCs and their subsidiaries. 179. Insurance Act, proposed subsection 36B(1) inserted by item 17 of Schedule 2 to the Bill. 180. Insurance Act, subsection 62K(1). 181. Insurance Act, subsections 62K(2) and (3). 182. Insurance Act, subsection 62M. 183. Insurance Act, proposed paragraph 62M(1)(iva) inserted by item 30 of Schedule 2 to the Bill and proposed subsection 62M(2) inserted by

item 32 of Schedule 2 to the Bill.

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In addition, the Bill repeals and replaces section 62T of the Insurance Act to make clear that a person with the powers and functions of an officer of the general insurer immediately before the appointment of the judicial manager ceases to have those powers and functions. Similarly a person with the powers and functions of an agent of a foreign general insurer ceases to have those powers and functions.185

The Bill also imbues the judicial manager with immunity from civil or criminal liability in equivalent terms to those in the Banking Act—that is, it extends to an act done or not done, provided that the act or omission was not in bad faith.186

Statutory management of general insurers Currently the Insurance Act does not provide for the statutory management of a general insurer. Item 58 of Schedule 2 to the Bill inserts proposed Division 1A—Statutory Management of General Insurers into Part VB of the Insurance Act.

The new Division:

1. empowers APRA to take control of a general insurer’s business or appoint an administrator to take control of the business in order to protect policy holders—provided that certain conditions are met187

2. in relation to a business that is incorporated in Australia and is an authorised NOHC of a general insurer, a subsidiary of an authorised NOHC of a general insurer or a subsidiary of a general insurer (called a target body corporate)—to take control of the business of the target body corporate or appoint an administrator to take control of the business of the target body corporate provided that certain conditions are met188

3. provides that the statutory manager is an Insurance Act statutory manager189

4. sets the circumstances in which control will commence190 and terminate191 and

5. details the functions and powers of the statutory manager and192

6. provides safeguards on the exercise of the Insurance statutory manager’s powers.193

These provisions are in equivalent terms to those which are inserted into the Banking Act by items 65, 79 and 131 of Schedule 1 to the Bill.

Scrutiny of Bills Committee Amongst the functions and powers of the Insurance Act statutory manager is the power to require a person who has, at any time, been an officer of the body corporate, to provide information including to produce books, accounts and documents.194 A person commits an offence if the person fails to provide the information or to produce the books, accounts and documents as requested. The maximum penalty for the offence is imprisonment for 12 months. A person is not excused from complying with such a requirement on the ground that doing so would tend to incriminate the person or make him, or her, liable to a penalty.

The Scrutiny of Bills Committee was concerned that this provision (and its equivalents in the other Industry Acts) overrides the common law privilege against self-incrimination. As the Explanatory Memorandum to the Bill does not provide an explanation for the provision, the Committee asked the Minister for further information.

In response the Treasurer stated:

184. Insurance Act, proposed subsections 62R(1A) and (1B) inserted by item 35 of Schedule 2 to the Bill. 185. Insurance Act, proposed subsection 62T(1) inserted by item 38 of Schedule 2 to the Bill. See item 149 of Schedule 1 to the Bill. 186. Insurance Act, proposed section 62ZM inserted by item 56 of Schedule 2 to the Bill. 187. Insurance Act, proposed subsections 62ZOA(1) and (2) inserted by item 56 of Schedule 2 to the Bill. 188. Insurance Act, proposed subsections 62ZOA(3)- (7) inserted by item 56 of Schedule 2 to the Bill. 189. Insurance Act, proposed subsection 62ZOA(8). 190. Insurance Act, proposed section 62ZOB. 191. Insurance Act, proposed section 62ZOC. 192. Insurance Act, proposed section 62ZOD. 193. Insurance Act, proposed section 62ZOE. 194. Insurance Act, proposed subsection 62ZOD(2) inserted by item 58 of Schedule 2 to the Bill. See also Life Insurance Act, proposed subsection

179AD(2) inserted by item 52 of Schedule 3 to the Bill.

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Overriding the privilege against self-incrimination is justified in this context because only the key personnel of a relevant entity will have access to information and documents relating to that entity's financial condition. It is essential for a statutory manager to be able to obtain this information quickly to assist with the management and crisis resolution of a relevant entity that is financially distressed. By compelling relevant officers or ex-officers to provide the required information and documents, statutory managers will be able to maximise their ability to rehabilitate a distressed entity. This will benefit the entity's customers, creditors and other suppliers. In the event of a significant crisis, APRA would also be able to use the information gathered to support decision making and prevent contagion in the system.

195

In addition to its concerns about the privilege against self-incrimination, the Scrutiny of Bills Committee noted that proposed subsection 62ZOD(5)196 provides that information given in compliance with the requirement is not admissible in evidence against the individual in a criminal proceeding or a proceeding for the imposition of a penalty, other than a proceeding in respect of the falsity of the information if, prior to giving the information the individual claims that the information might tend to incriminate him or her or expose them to a penalty. This is called a use immunity.

However, the Bill does not contain a derivative use immunity. This means that any information obtained as an indirect consequence of the production of the information or documents may be admissible in evidence against the person. The Scrutiny of Bills Committee questioned the absence of such an immunity.197

In response to the Committee’s inquiry the Treasurer stated:

… if derivative use immunity applied, it would often be very difficult for the prosecution to show that the evidence they rely on to prove a criminal case against an officer relating to the failure of the financial institution was uncovered through an absolutely independent and separate investigation process. This may in turn lead to hesitation on the part of a statutory manager to exercise the information-obtaining power, undermining the purpose for which the power was conferred.

198

The Treasurer also pointed out that the provisions are consistent with the majority of existing self-incrimination provisions in other APRA-administered legislation, including provisions in the Superannuation Industry (Supervision) Act 1993 and Private Health Insurance (Prudential Supervision) Act 2015.199

Human Rights Committee The Human Rights Committee also expressed concern about this provision from the perspective of the International Covenant on Civil and Political Rights (ICCPR).200 Article 14 of the ICCPR guarantees the right to a fair trial. Article 14(3)(g) includes the right not to incriminate oneself.

According to the Human Rights Committee:

… the availability of 'use' and 'derivative use' immunities can be one important factor in determining whether the limit on the right not to incriminate oneself is proportionate. That is, they may act as a relevant safeguard … However, no 'derivative use' immunity is provided for proposed sections 62ZOD and 179AD, which would prevent information or evidence indirectly obtained from being used in criminal proceedings against the person.

201

The Treasurer responded to the concern expressed by the Human Rights Committee in similar terms to those contained in his response to the Scrutiny of Bills Committee.202

195. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 15, 2017, op. cit., p. 71. 196. See also Life Insurance Act, proposed subsection 179AD(5) inserted by item 52 of Schedule 3 to the Bill. 197. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 13, 2017, op. cit., p. 32. 198. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 15, 2017, op. cit., p. 72. 199. Ibid. 200. International Covenant on Civil and Political Rights, done in New York on 16 December 1966, [1980] ATS 23 (entered into force for Australia

(except Art. 41) on 13 November 1980; Art. 41 came into force for Australia on 28 January 1994). 201. Parliamentary Joint Committee on Human Rights, Human rights scrutiny report, 12, 2017, op. cit., p. 27. 202. Parliamentary Joint Committee on Human Rights, Human rights scrutiny report, 1, 2018, op. cit., pp. 99-102.

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Recapitalisation The existing recapitalisation provisions in the Banking Act are subject to minor amendments by Schedule 1 to the Bill. Schedule 2 to the Bill inserts recapitalisation provisions into the Insurance Act.

Under the Bill, an Insurance Act statutory manager of a body corporate that is a company that has a share capital and is registered under the Corporations Act may do one or more of the following acts:

• issue shares, or rights to acquire shares, in the company

• cancel shares, or rights to acquire shares, in the company

• reduce the company’s share capital by cancelling any paid-up share capital that is not represented by available assets

• sell shares, or rights to acquire shares, in the company or

• vary or cancel rights or restrictions attached to shares in a class of shares in the company.203

The Insurance Act statutory manager must give written notice to the persons who were members of the company just before he or she took the relevant action, identifying the action and explaining its effect on their interests as members.204

Importantly before undertaking any of the above actions the Insurance Act statutory manager must obtain and consider a report about the fair value of the shares or rights concerned from an expert who is not an associate of the statutory manager or of the company.205

The method for determining the fair value for each share is a three step process. The first step is for the expert to assess the value of the company as a whole, in accordance with any assumptions which the Minister has provided.206 The second step is for the expert to allocate that value among the classes of shares in the company that either have been issued or that the Insurance Act statutory manager proposes to issue. The third step is for the expert to allocate the value of each class pro rata among the shares in that class that either have been issued or that are proposed to be issued.207

However, there is an exception to the general rule that an expert report must first be obtained. That occurs where APRA is satisfied that delaying the relevant action to enable the report to be obtained would detrimentally affect policyholders with the insurer and financial system stability in Australia.208 Where APRA makes a determination to that effect it must be published in the Gazette and a copy given to the Insurance Act statutory manager concerned.209

The Bill inserts provisions which provide the Insurance Act statutory manager immunity from civil or criminal liability in equivalent terms to those that are inserted into the Banking Act by item 149 of Schedule 1 to the Bill.210

Administrator in control of an insurer In some circumstances an external administrator may be appointed to an entity in a group. The financial distress of that entity may cause or exacerbate distress in an insurer—for example through interruption to essential services provided to the insurer by the entity.

Schedule 2 to the Bill inserts the following requirements for external administrators:

1. an administrator of a body corporate’s business must give APRA, upon request, a written report showing how the control of the body corporate’s business is being carried out211

203. Insurance Act, proposed subsection 62ZOF(1). 204. Insurance Act, proposed subsection 62ZOF(2). 205. Insurance Act, proposed subsection 62ZOG(1) and (2). 206. Insurance Act, proposed subsection 62ZOG(4) empowers the Minister to give the expert written notice of assumptions. The notice is not a

legislative instrument so it cannot be disallowed by the Parliament. 207. Insurance Act, proposed subsection 62ZOG(3). 208. Insurance Act, proposed subsection 62ZOG(8). 209. Insurance Act, proposed subsection 62ZOG(9). 210. Insurance Act, proposed section 62ZOK.

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2. on termination of his, or her, appointment an administrator of a body corporate’s business must give to APRA a written report showing how the control of the body corporate’s business was carried out over the period of the administrator’s appointment212

3. an external administrator must follow directions given to it by APRA213 and

4. where an administrator of a body corporate’s business has reasonable cause to believe that an action that he, or she, proposes to take is likely to have a detrimental effect on financial system stability in Australia, the administrator must notify APRA as soon as practicable and obtain APRA’s written consent before taking the action. 214

APRA may terminate the appointment of an administrator of a body corporate’s business if the administrator contravenes any of the requirements set out above or if APRA considers it is necessary to do so to facilitate the resolution of the body corporate, to protect the interests of policyholders of a general insurer or to promote financial system stability in Australia.215 In that case, APRA may either appoint another person as the administrator of the body corporate’s business or take control of the body corporate’s business itself.

The appointment of an external administrator of a body corporate is terminated when an Insurance Act statutory manager takes control of the body corporate’s business. 216 The Bill inserts moratorium provisions in equivalent terms to those inserted by item 33 of Schedule 2 to the Bill.217

Winding up The Bill extends APRA’s existing powers in the winding up of an insurer to also cover an authorised NOHC, a subsidiary of a general insurer or authorised NOHC218 and to a foreign general insurer.219

Financial claims scheme Part VC of the Insurance Act relates to the operation of the financial claims scheme. Item 68 of Schedule 2 to the Bill broadens the purpose of Part VC so that it includes allowing APRA to facilitate a transfer of business from the declared general insurer to a receiving body under the Financial Sector (Transfer and Restructure) Act 1999 by entitling the receiving body to amounts in respect of the protected policies.220

The Bill provides that the financial claims scheme may be activated by the Minister if a general insurer is under either judicial management or statutory management, or where an external administrator for the general insurer has been appointed under the Corporations Act.221

Schedule 2 to the Bill:

1. provides for interim claims and payments to be made under the scheme to holders of protected policies222

2. provides for interim claims and payments to be made under the scheme to third parties holders of protected policies223

3. empowers APRA to make a transferred liabilities determination224 and to issue a certificate of transfer under the FSTR Act225 and

211. Insurance Act, proposed subsection 62ZOM(1). 212. Insurance Act, proposed subsection 62ZOM(2). 213. Insurance Act, proposed subsection 62ZOM(3). 214. Insurance Act, proposed section 62ZON. 215. Insurance Act, proposed subsection 62Z00(1). 216. Insurance Act, proposed subsection 62Z0Q(1). 217. Insurance Act, proposed sections 62Z0R-62ZOW. 218. Insurance Act, proposed subsection 62ZR(4) inserted by item 61 of Schedule 2 to the Bill. Note that items 62 and 63 make consequential

amendments. 219. Insurance Act, proposed subsection 62ZU(3) inserted by item 64 and proposed section 62ZVA inserted by item 66 of Schedule 2 to the Bill. 220. Insurance Act, proposed paragraph 62ZW(d) inserted by item 68 of Schedule 2 to the Bill. 221. Insurance Act, proposed paragraph 62ZZC(1)(a) inserted by item 69 of Schedule 2 to the Bill. 222. Insurance Act, proposed section 62ZZFA inserted by item 71 of Schedule 2 to the Bill. 223. Insurance Act, proposed section 62ZZGA inserted by item 75 of Schedule 2 to the Bill.

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4. creates a liability on the part of a declared general insurer to pay to APRA an amount equal to the total payment amount specified in the transferred liabilities determination.226

Recapitalisation directions Existing Part IX of the Insurance Act sets out the circumstances in which APRA may make a recapitalisation direction.

Schedule 2 to the Bill:

1. broadens APRA’s power to make a recapitalisation direction to include the power to give such a direction to a NOHC/NOHC subsidiary of which a general insurer is a subsidiary227

2. provides that the recapitalisation direction may set out the time by which it must be complied with228

3. sets out the types of recapitalisation direction that may be given to a NOHC/NOHC subsidiary229

4. clarifies the other types of direction that APRA may give under the Insurance Act so that they are in equivalent terms to those in the Banking Act.230

Secrecy and disclosure Item 135 inserts proposed Division 3—Secrecy and disclosure provisions relating to all directions into Part IX of the Insurance Act. Within the new Division are proposed sections 109-109H which are in equivalent terms to proposed sections 11CH-11CP of the Banking Act which are inserted by item 56 of Schedule 1 to the Bill.

Protection from liability Item 137 of Schedule 2 to the Bill inserts proposed sections 127B-127E into the Insurance Act. In particular, proposed section 127B of the Insurance Act contains general protections from liability so that a person is not subject to any liability to any other person in respect of anything done, or omitted to be done, in good faith and without negligence in the exercise or performance, or the purported exercise or performance, of powers, functions or duties under the Insurance Act.

The protection from liability arising from an action to comply with a direction by APRA in proposed section 127C is in equivalent terms to the protection in proposed section 70AA of the Banking Act which is inserted by item 252 of Schedule 1 to the Bill.

Amending the Life Insurance Act Background As at 8 February 2018, there were 29 registered life insurers operating in Australia.231 Life insurance generally covers a range of insurance products including:

• life cover—also known as term life insurance or death cover, pays a set amount of money when the insured person dies

• total and permanent disability (TPD) cover—covers the costs of rehabilitation, debt repayments and the future cost of living if the insured person is totally and permanently disabled

• trauma cover—provides cover in the event of a diagnosis of a specified illness or injury and

• income protection—replaces the income lost through an inability to work due to injury or sickness.232

224. Insurance Act, proposed section 62ZZMA inserted by item 84 of Schedule 2 to the Bill. 225. Insurance Act, proposed section 62ZZMC inserted by item 84 of Schedule 2 to the Bill. 226. Insurance Act, proposed subsection 62ZZMC(4). 227. Insurance Act, proposed subsections 103A(2)-(5) inserted by item 96 of Schedule 2 to the Bill. 228. Insurance Act, proposed subsection 103B(4) inserted by item 100 of Schedule 2 to the Bill. 229. Insurance Act, proposed subsection 103C(1A)-(1C) inserted by item 101 of Schedule 2 to the Bill. 230. Items 114-118 of Schedule 2 to the Bill. See items 34 to 37 of Schedule 1 to the Bill. 231. APRA, ‘Registered life insurance companies’, APRA website, 13 July 2016. 232. ASIC, Life insurance: claims: an industry review, Report 498, October 2016.

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The most common policy type across the industry is a stepped premium policy. The premium on a stepped premium policy increases each year according to risk factors such as the client’s age.233 According to a review of retail life insurance advice conducted by ASIC in 2014:

… life insurance policies are lapsing at high rates. For example, for stepped premium policies, we found that, in 2013, policy lapses doubled from approximately 7% in the first year to 14% in the second year. After the initial spike, lapse rates remain high (above 14%) for the next three years before tapering. 234

High lapse rates are problematic in the face of rising claims costs. 235 It has been reported that:

Greater product commoditisation is driving greater price competitiveness in an environment where many traditional life insurers are losing money due to inadequate risk pricing, while battling with huge regulatory and structural changes. 236

In the face of potential life insurance losses, it is timely that Schedule 3 to the Bill amends the Life Insurance Act to ensure that its provisions are consistent with those in the Banking Act and the Insurance Act.

Registration Rather than authorising a body corporate to undertake a banking or general insurance business (as in the Banking Act and the Insurance Act) the Life Insurance Act refers to registering life companies.237 However, consistent with the amendments in Schedules 1 and 2 to the Bill, Schedule 3 empowers APRA to impose conditions, or additional conditions, or to vary or revoke existing conditions on the body corporate’s authority at any time.238

A life company commits an offence of strict liability239 if it does an act or fails to do an act and as a result contravenes a condition of its registration.240 In that case the maximum penalty is 300 penalty units.241 An individual may commit the offence because of the provisions in Part 2.4 of the Criminal Code Act 1995, which extend criminal responsibility to a person who attempts to commit an offence, who aids abets, counsels, procures or incites the commission of an offence, or conspires with another person to commit an offence. The maximum penalty for an individual is a fine not exceeding 60 penalty units.242

Item 8 of Schedule 3 to the Bill repeals and replaces section 26 of the Life Insurance Act to list the legal requirements with which a life company must comply—or face the prospect that its registration will be revoked.243 In the event that APRA considers revocation of registration is appropriate, it may direct the life company to arrange to assign its liabilities to one or more other companies that are registered under the Life Insurance Act.244

APRA may only approve a proposed assignment of a company’s liabilities if it is satisfied that the assignment is appropriate, having regard to:

• the interests of the company’s policy owners

• the interests of the policy owners of the company or companies to which the liabilities are to be assigned

233. ASIC, Review of retail life insurance advice, Report 413, October 2014, p. 5. 234. Ibid. 235. A Uribe, ‘Life insurers urged to co-operate on data’, The Australian Financial Review, 3 January 2018, p. 17. 236. M Roddan, ‘Price rules as tech alters life insurance’, The Australian, 8 January 2018, p. 13. 237. Life Insurance Act, section 17. 238. Life Insurance Act, proposed section 22 inserted by item 7 of Schedule 3 to the Bill. 239. In a criminal law offence, the proof of fault is usually a basic requirement. However, offences of strict liability remove the fault (mental)

element that would otherwise apply, but the offence will not criminalise honest errors and a person cannot be held liable if he, or she, had an honest and reasonable belief that they were complying with relevant obligations. 240. Life Insurance Act, proposed section 23 inserted by item 7 of Schedule 3 to the Bill. 241. Under section 4AA of the Crimes Act 1914 a penalty unit is equivalent to $210. This means that the maximum penalty for the offence is

$63,000.

242. This means that the maximum penalty is $12,600. 243. Life Insurance Act, proposed section 26. A decision to revoke registration is a reviewable decision due to the amendments to existing subsection 236(1) of the Life Insurance Act in item 104 of Schedule 3 to the Bill. 244. Life Insurance Act, proposed section 27A inserted by item 11 of Schedule 3. A decision to give a direction to assign liabilities is a reviewable

decision due to the amendments to existing subsection 236(1) of the Life Insurance Act in item 104 of Schedule 3 to the Bill.

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• the public interest and

• any other matter APRA considers relevant.245

The approval must be in writing and may be made subject to specified conditions. 246

If a company (called the first company) accepts an assignment of liabilities from another company that has been approved by APRA, a policy owner of a transferring policy is taken to have the same rights against the first company as they would otherwise have had.247

The Life Insurance Act already contains provisions for the registration of a NOHC.248 Item 14 of Schedule 3 to the Bill inserts proposed section 28BA into the Life Insurance Act to create an offence with a maximum penalty of 300 penalty units where a body corporate does or fails to do an act which results in a contravention of a condition of the body corporate’s NOHC registration. In addition, item 17 of Schedule 3 to the Bill inserts proposed section 28AA into the Life Insurance Act empowering APRA to give a notice to a body corporate that is a holding company of a life company (where the life company is not a subsidiary of a registered NOHC) requiring the body corporate to either become a registered NOHC of the life company or that one of its subsidiaries becomes a registered NOHC of the life company.

Judicial management Similar to the Insurance Act, the Life Insurance Act provides for judicial management, other external administration and winding up of a life company.249

Schedule 3 to the Bill:

1. expands the list of the circumstances in which APRA may make an application to the Court to place a life company under judicial management250

2. inserts moratorium provisions in respect of a life company that is under judicial management.251 These moratorium provisions are in equivalent terms to those that are inserted into the Insurance Act by item 33 of Schedule 2 to the Bill

3. empowers a Court to appoint a substitute judicial manager or an additional judicial manager in certain circumstances252

4. clarifies the effect of judicial management on the powers of officers—so that the judicial manager has the powers and functions of an officer of the company253 and

5. provides immunity from liability for a judicial manager in respect of anything done, or omitted to be done in the exercise or performance of his, or her, duties under the Life Insurance Act.254

Statutory management of life companies Currently the Life Insurance Act does not provide for the statutory management of a life company. Item 52 of Schedule 3 to the Bill inserts proposed Division 1AA—Statutory Management of Life Company into Part 8 of the Life Insurance Act. Essentially, the provisions of new Division 1AA of the Life Insurance Act will ensure that a Life Insurance Act statutory manager will have the same functions and duties as a statutory manager under the Banking Act and the Insurance Act.

Amongst other things the new Division:

245. Life Insurance Act, proposed subsection 27A(4) inserted by item 11 of Schedule 3 to the Bill. A refusal to approve the assignment of liabilities is a reviewable decision due to the amendments to existing subsection 236(1) of the Life Insurance Act in item 104 of Schedule 3 to the Bill. 246. A decision to impose conditions on an approval to assign liabilities is a reviewable decision due to the amendments to existing subsection 236(1) of the Life Insurance Act in item 104 of Schedule 3 to the Bill. 247. Life Insurance Act, proposed subsection 27A(5). 248. Life Insurance Act, section 28A. 249. Life Insurance Act, Part 8. 250. Life Insurance Act, proposed subparagraphs 159(a)(iiia)-(iiic) inserted by item 26 of Schedule 3 to the Bill. 251. Life Insurance Act, proposed sections 161-161E inserted by item 28 of Schedule 3 to the Bill. 252. Life Insurance Act, proposed subsections 163(1A) and (1B) inserted by item 30 of Schedule 3 to the Bill. 253. Life Insurance Act, proposed section 165 inserted by item 33 of Schedule 3 to the Bill. 254. Life Insurance Act, proposed section 179 inserted by item 51 of Schedule 3 to the Bill.

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1. empowers APRA to take control of a life company’s business or appoint an administrator to take control of the business in order to protect the soundness of the life company or the interest of policy holders— provided that certain conditions are met255

2. in relation to a business that is incorporated in Australia and is a registered NOHC of a life company, a subsidiary of a registered NOHC of a life company or a subsidiary of a life company (called a target body corporate)—to take control of the business of the target body corporate or appoint an administrator to take control of the business of the target body corporate provided that certain conditions are met256

3. provides that the statutory manager is an Life Insurance Act statutory manager257

4. sets the circumstances in which control will commence258 and terminate259

5. details the functions and powers of the Life Insurance Act statutory manager260 and

6. provides safeguards on the exercise of the Life Insurance Act statutory manager’s powers.261

These provisions are in equivalent terms to those which are inserted into the Banking Act by items 65, 79 and 131 of Schedule 1 to the Bill.

In addition, Schedule 3 to the Bill empowers the Life Insurance Act statutory manager to do specified acts, including but not limited to issuing shares, cancelling shares and reducing the company’s share capital by cancelling any paid-up share capital that is not represented by available assets.262 In that case, the Life Insurance Act statutory manager must take equivalent steps to those taken under the Banking Act and the Insurance Act to determine the fair value of each share.263

Winding up a life company Existing section 181 of the Life Insurance Act provides that APRA may apply for an order that a life company be wound up.

Schedule 3 to the Bill:

1. amends section 181 so that APRA may apply for such an order only if certain conditions are met264 and

2. authorises APRA to ask a liquidator for specified information in writing about the winding-up of a life company, a registered NOHC and a subsidiary of a life company or a registered NOHC.265

Conversion and write off provisions Existing Part 10A of the Life Insurance Act is about prudential standards and directions. Item 63 of Schedule 3 to the Bill inserts proposed section 230AAA into the Act to require a life company, registered NOHC or a subsidiary of a life company or registered NOHC to which a prudential standard applies to comply with the standard. For example Life Insurance (prudential standard) determination No. 2 of 2012 (Prudential standard LPS 110: capital adequacy) requires a life company to maintain adequate capital against the risks associated with its activities.

Item 64 of Schedule 3 to the Bill inserts proposed Division 1A—Conversion and write-off provisions into Part 10A of the Life Insurance Act. The provisions are in equivalent terms to those which are inserted into the Banking Act and the Insurance Act by this Bill.

Currently, APRA may give a life company a direction (a recapitalisation direction) that requires the company to increase its level of capital to the level specified in the direction in certain circumstances.266 This is called a

255. Life Insurance Act, proposed subsections 179AA(1) and (2) inserted by item 52 of Schedule 3 to the Bill. 256. Life Insurance Act, proposed subsections 179AA(3)-(7) inserted by item 52 of Schedule 3 to the Bill. 257. Life Insurance Act, proposed subsection 179AA(8). 258. Life Insurance Act, proposed section 179AB. 259. Life Insurance Act, proposed section 179AC. 260. Life Insurance Act, proposed section 179AD. 261. Life Insurance Act, proposed section 179AE. 262. Life Insurance Act, proposed section 179AF. 263. Life Insurance Act, proposed section 179AG. 264. Life Insurance Act, proposed subsections 181(2) and 181(4) inserted by items 54 and 55 of Schedule 3 to the Bill respectively. 265. Life Insurance Act, proposed subsections 183(4) and 185(1) inserted by items 57 and 60 of Schedule 3 to the Bill respectively. 266. Life Insurance Act, subsection 230AB(1).

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primary recapitalisation direction. Item 68 of Schedule 3 to the Bill operates to permit APRA to also give a recapitalisation direction to the relevant NOHC/NOHC subsidiary in order to facilitate compliance with a primary recapitalisation direction.267 A recapitalisation direction may set out the time during which the direction must be complied with.268

Consistent with the above, a recapitalisation direction to a NOCH/NOHC subsidiary may direct that body corporate to do any of the following:

• issue shares, or rights to acquire shares or other capital instruments in the NOHC/NOHC subsidiary

• acquire shares, or rights to acquire shares or other capital instruments in the life company

• acquire shares, or rights to acquire shares, or other capital instruments in a specified body corporate.269

APRA already has the power to give a body corporate that is a life company or a registered NOHC a direction.270 Subsection 230B(1) sets out triggers for APRA to give directions based on the behaviour of the body corporate itself, while subsection 230B(1AA) sets out triggers based on the behaviour of subsidiaries of the body corporate.

Item 84 of Schedule 3 to the Bill repeals existing subsection 230B(1AA) and inserts proposed subsections 230B(1AA)-(1AE) into the Life Insurance Act. to expand the list of matters that might give rise to the giving of a direction by APRA to include certain conduct by the subsidiary of the body corporate. Proposed subsection 230B(1AA) significantly expands the list of matters which might act as a trigger for APRA to issue a direction to a body corporate based on the behaviour of one of its subsidiaries, such that the triggers will largely mirror those in subsection 230B(1). However, proposed subsection 230B(1AB) qualifies APRA’s power in that APRA can only issue a direction to an ADI or authorised NOHC in response to certain triggers under subsection 230B(1AA) if it is reasonably necessary for one or more prudential matters relating to the body corporate. In addition, Schedule 3 to the Bill adds the following to the list of directions that APRA may give a body corporate:

• to make changes to the body corporate’s systems, business practices or operations

• to reconstruct, amalgamate or otherwise alter all or part of the business, structure or organisation of the body corporate itself or of the group constituted by the body corporate and its subsidiaries

• to do, or to refrain from doing, anything else in relation to the affairs of the body corporate.271

The latter of these directions is further expanded upon by the Bill so that a direction under that paragraph to an eligible foreign life insurance company may be:

• a direction that the company act in a way so as to ensure that

- a particular asset, or a particular class of assets, of the company is returned to the control of the part of the company’s life insurance business that is carried on in Australia or - a particular liability, or a particular class of liabilities, of the company ceases to be the responsibility of the part of the company’s life insurance business that is carried on in Australia • a direction that the company not act in a way that has the result that:

- a particular asset, or a particular class of assets, of the company ceases to be under the control of the part of the company’s life insurance business that is carried on in Australia or - a particular liability, or a particular class of liabilities, of the company becomes the responsibility of the part of the company’s life insurance business that is carried on in Australia.272 Consistent with the amendments in Schedules 1 and 2 to the Bill, item 102 inserts proposed Subdivision C— Secrecy and disclosure provisions relating to all directions into Division 2 of Part 10A of the Life Insurance Act. These provisions are in equivalent terms to those inserted into the Banking Act by item 56 of Schedule 1 to the Bill and those inserted into the Insurance Act by item 135 of Schedule 2 to the Bill.

267. Life Insurance Act, proposed subsections 230AB(1A) and (1B) inserted by item 68 of Schedule 3 to the Bill. 268. Life Insurance Act, proposed subsection 230AB(4) inserted by item 70 of Schedule 3 to the Bill. 269. Life Insurance Act, proposed subsection 230AC(1A) inserted by item 71 of Schedule 3 to the Bill. 270. Life Insurance Act, section 230B. 271. Life Insurance Act, proposed paragraphs 230B(2)(v)-(x) inserted by item 87 of Schedule 3 to the Bill. 272. Life Insurance Act, proposed subsection 230B(3A) inserted by item 88 of Schedule 3 to the Bill.

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Other provisions Schedule 4 Schedule 4 to the Bill amends the Financial Sector (Business Transfer and Group Restructure) Act. The amendments, including the change of name to the Financial Sector (Transfer and Restructure) Act are intended to complement the provisions which have been inserted into the Industry Acts as above. Prior to the enactment of the FSTR Act the Government and the Reserve Bank used mergers as a prudential tool to deal with banks in financial distress. However there was no formal power in the hands of regulators to order a merger or transfer of business between banks or insurance companies. The FSTR Act (when enacted) provided APRA with ‘an efficient and effective tool for protecting depositors or policy owner monies where their institution is in severe financial hardship’.273

The amendments in Schedule 4 insert new definitions in equivalent terms to those that are inserted by Schedules 1-3 of the Bill, for instance Australian business assets and liabilities274 or formalise the meaning of terms which are used in the Industry Acts such as certificate of transfer.

The key features of the amendments in Schedule 4 to the Bill are:

• in certain circumstances APRA may transfer the shares in a failing regulated entity from the existing shareholders to a body corporate275

• APRA may determine that there is to be a total or partial transfer of business from a body corporate that is related to a general or life insurer (but is not itself an ADI, general insurer or life insurer) to another body corporate under certain circumstances276 and

• APRA may give effect to transfers of business even in the absence of state or territory legislation being in place to facilitate transfers of business.277

Concluding comments The most controversial aspect of this Bill is that it formalises the ability of ADIs, general insurers and life companies to convert or write off certain of their financial instruments if a trigger event occurs.

Whilst convertible instruments have been in the market for some time, it is only with this Bill that the law puts beyond doubt that conversion may occur.

Whilst this does not impact ordinary deposits, it is important for investors to understand the possible consequences of purchasing a convertible financial product.

273. B Heffernan, ‘Second reading speech: Financial Sector Reform (Transfers of Business) Bill 1999’, Senate, Debates, 30 March 1999, p. 3499. 274. Inserted into the Banking Act by item 59 of Schedule 1 to the Bill; inserted into the Insurance Act by items 1 and 66 of Schedule 2 to the Bill and inserted into the Life Insurance Act by item 6 of Schedule 3 to the Bill. 275. FSTR Act, proposed section 25AA inserted by item 55 of Schedule 4 to the Bill. 276. FSTR Act, proposed subsections 25(1DA) and 25(1G) inserted by items 47 and 52 of Schedule 4 to the Bill. 277. FSTR Act, proposed paragraph 11(1)(d) inserted by item 28 of Schedule 4 to the Bill.

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