On 12 June the Australian Securities & Investments Commission (ASIC) announced the final regulatory regime for Financial Benchmarks. This regime, introduced through a 2018 amendment to the Corporations Act 2001, empowers ASIC to determine that certain benchmarks are ‘significant’ and to impose a licensing regime on the ‘administrators’ of those benchmarks. In today’s article, we ask, what is the new Financial Benchmark Regime?

Photo by Paul Gilmore on Unsplash

By Dr Drew Donnelly, Regulatory Specialist, Compliance Quarter

Background: What is a Financial Benchmark?

A Financial Benchmark has been defined as:

an index or indicator calculated from a representative set of underlying data or information, used as a reference price for a financial instrument or financial contract or to measure the performance of an investment fund.^[1]

Reliable Financial Benchmarks are crucial to the operation of financial markets. If Financial Benchmarks are inaccurate, that is, they fail to reflect underlying forces of supply and demand, financial markets cannot efficiently allocate capital. Inaccurate Financial Benchmarks can happen for a range of reasons, including intentional behaviour of traders, such as:

• trading with the intent of altering a benchmark rate for a financial institution’s own benefit;
• inappropriate handling of client orders or positions;
• inappropriate disclosure of confidential client information (e.g. by disclosing client orders to traders at competing banks);
• inappropriate submitter conduct (e.g. by making submissions in order to reduce the institution’s borrowing costs).^[2]

A licensing regime has been introduced in order to counteract and prevent such behaviour.

The Five Significant Financial Benchmarks

The five significant Financial Benchmarks are:

• The Australian Bank Bill Swap Rate (BBSW) administered by ASX Benchmarks Pty Ltd. This identifies a set of key short-term interest rate benchmarks for the Australian dollar and is the key reference rate used by issuers of securities in Australian dollars;
• The S&P/ASX200 Index administered by S&P Dow Jones Indices LLC. This is an equity index which measures the performance of the 200 largest index-eligible stocks listed on the ASX;
• The ASX Bond Futures Settlement Price administered by ASX Clear (Futures) Pty Limited. This is used to calculate the value of Bond futures contracts for 3-, 10- and 20-year Australian Government bonds listed on the ASX;
• The Australian Interbank Overnight Cash Rate administered by the Reserve Bank of Australia. This consists in the weighted average of the interest rate at which overnight unsecured funds are transacted in the domestic interbank market. The Cash Rate is the Reserve Bank Board’s operational target for monetary policy and is also an important benchmark for the Australian financial markets.
• The Australian Consumer Price Index (CPI) administered by the Australian Bureau of Statistics.  This measures quarterly changes in the price of a range of goods and services which are a significant portion of household expenditure. It is a benchmark in a for many financial products, including bonds and derivatives.^[3]

The Financial Benchmark Licensing Framework

Under Part 7.5B of the Corporations Act 2001, ASIC is empowered to set up a licensing regime for administrators of financial benchmarks that are designated ‘significant’. Central to the licensing regime for the administrators of these Financial Benchmarks are the following obligations:

• a requirement to act efficiently, honestly and fairly in generating and administering each benchmark specified in its licence;
• having adequate arrangements for the governance and management of the licensee. These must be reviewed, audited and tested periodically;
• if outsourcing any of the functions involved in generating or administering a licensed benchmark, documenting this and having adequate arrangements put in place to ensure compliance;
• transparency to the public with respect to the benchmarks;
• a requirement to co-operate with ASIC;
• having adequate arrangements for handling conflicts of interest in relation to generating and administering each of its licensed benchmarks;
• a requirement to have sufficient human, technological and financial resources in place;
• record-keeping obligations.

To read more about the new Financial Benchmark regime go to https://asic.gov.au/about-asic/media-centre/find-a-media-release/2018-releases/18-171mr-asic-implements-financial-benchmark-regulatory-regime/.

Feel free to leave a comment or contact us if you’d like further information or have any questions.

[1] See ASIC Report 440: Financial Benchmarks (2015) at http://download.asic.gov.au/media/3285136/rep440-published-8-july-2015.pdf, para 20.

[2] Ibid, para 46.

[3] See ASIC Corporations (Significant Financial Benchmarks) Instrument 2018/420, section 5 and associated Explanatory Statement, section 4.

Last month’s wealth management hearings before the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Banking Royal Commission) highlighted the need for AFS licensees to understand and fully comply with their breach reporting obligations in a timely and not overly legalistic way. You can read more about our coverage of the issues coming out of the Banking Royal Commission here https://www.compliancequarter.com.au/tech-lies-and-litigation-asic-reads-the-riot-act-to-the-financial-services-industry/

In our article covering AFSL breach reporting obligations we take a closer look at those obligations and the consequences of non-compliance.

What must an AFS licensee report?

AFS licensees must notify ASIC in writing of any ‘significant’ breach (or likely breach) of their obligations under s912A (including licence conditions), s912B (compensation arrangements) or financial services laws, as soon as possible, and in any event within ten (10) business days of becoming aware of the breach or likely breach. If you don’t tell ASIC about a significant breach (or likely breach) then ASIC will consider that this itself is a significant breach. As such, an AFS licensee should have a clear, well-understood and documented process for identifying and reporting breaches. It is worth noting that, responsible entities are also subject to breach reporting requirements.

AFSL breach reporting obligations – What does ‘significant’ breach mean?

Whether a breach is significant will depend on the individual circumstances – it is a subjective assessment. As such, licensees need to give proper consideration to whether the breach (or likely breach) is significant, and, if so, provide timely notification to ASIC. You will need to decide whether a breach (or likely breach) is significant and therefore, reportable to ASIC.

What factors determine whether is a breach is ‘significant’?

The non-exhaustive list of factors that determine whether a breach (or likely breach) is ‘significant’ include:
• the number or frequency of similar previous breaches;
• the impact of the breach or likely breach on the licensee’s ability to provide the financial services covered by the licence;
• the extent to which the breach or likely breach indicates that the licensee’s arrangements to ensure compliance with those obligations is inadequate; and
• the actual or potential loss to clients or the licensee itself.

If you are not sure whether a breach is significant, ASIC has indicated you should err on the side of caution and report the breach. ASIC Regulatory Guide 78 ‘Breach reporting by AFS Licensees’ (RG78) also provides further guidance as to how ASIC interprets and will apply the law.

How do you report a breach?

A breach can be reported to ASIC by completing Form FS80 and/ or written report to ASIC via email at [email protected]

What are the penalties for non-compliance?

It is important that licensees report significant breaches to ASIC as early as possible, even where you are still gathering further information on the breach. ASIC states in RG78 that a failure to report a significant breach is an offence and may itself result in penalties up to $42,500 for companies.

What are the key takeaways?

The insights that have been emanating from the Banking Royal Commission, it’s coverage and associated regulatory matters, are that breach reporting is an area where there has been significant divergence by AFS licensees in how they are managing that process. The issue of governance internally around the breach reporting process has itself been a matter of considerable focus and debate – the ability of those charged with the responsibility to escalate incidents for consideration within the breach reporting framework and bring those to the attention of the board of licence holders in particular.

If you’re an AFS licence holding entity (or on the board of an entity that is) now is the time to be reviewing your breach reporting and incident management policies and considering the workflows within your organisation for how such matters are to be managed. At the board level, you should also be reflecting on what has been coming through from your audit and risk committee reports and whether there have been any details around incidents or breaches reported recently. If not, it may be worth contemplating a review of that process to ensure that adequate transparency is being afforded internally to such matters. Other matters that AFS licence holders should be reflecting on in this space include, how remuneration is structured for senior management and at the board level when there have been breaches identified and reported and ensuring that remuneration structures align with the obligations of the AFS licensee – for example, clawbacks or bonus ineligibility where there has been a major incident or significant breach. It would also be worth looking at how the organisation is learning from incidents and breaches – are they applying the right tools to identify how and why the incident or breach occurred along with adopting a lessons-learned mindset to avoid any future repeats within the business.

AFSL breach reporting obligations – Need more assistance?

If you would like assistance with better understanding your breach reporting obligations or an assessment of your internal procedures for managing issues in this space, please get in touch with us at Compliance Quarter and one of our regulatory specialists would be pleased to assist you.

Is it just us or is having your own digital bank the new must-have item at the moment? The announcement by APRA late last week that it had signed off on Australia’s first ever digital bank under a restricted licensing regime came as no surprise to those who have been monitoring the debate around how to increase competition in the banking sector.

You can read more about the restricted banking licence granted by APRA last week to Volt Bank Limited application by accessing our previous coverage on it – click here to view.

So, if owning your own bank is the next-big-thing, in the world of fintech, how does one go about getting a piece of the banking pie for themselves? Today we will take a closer look at forming a bank within the process used by the Australian Prudential Regulatory Authority (APRA) under the restricted licensing regime.

Who is the regulator of banking in Australia?

If you posed this question to the ordinary person on the street many would no doubt say that the Australian Securities and Investments Commission (ASIC) is the regulator of banks in Australia. It is true that ASIC regulates the banks in so far as they hold an Australian Financial Services Licence (AFSL), but the use of that AFSL is generally limited to the banks’ activities pertaining to the provision of wealth management, credit or wholesale banking products and services.

The primary regulator of banks in Australia is APRA, who under the twin financial regulators model that is used in Australia, is charged with responsibility for the licensing and prudential supervision of Authorised Deposit Taking Institutions (ADIs), life and general insurance companies and superannuation funds.

Forming a Bank – How does one get a licence to operate a bank?

An organisation that wishes to conduct banking business must apply to APRA for a licence authorising it to conduct business banking under the Banking Act 1959 (Cth) (Banking Act). An organisation that has been granted a banking licence under the Banking Act by APRA is thereafter known as an authorised deposit taking institution (ADI).

Achieving an ADI licence requires significant resources and capabilities, for this reason, there are two routes available to become an ADI: the direct route and the restricted route.

The direct route allows an applicant to conduct their intended banking business from the granting of the licence. The precursor to that being, the applicant must demonstrate that it meets the prudential framework and be ready to commence banking business the granting of the licence.

As the name suggests, the restricted route provides an applicant with a restricted licence for a maximum of two years before they must meet the prudential framework in full. If after two years they are unable to attain those prudential standards they must exit the banking sector. It is similar in operation to the regulatory sandbox that ASIC has created for eligible fintechs who are seeking to validate their concept prior to obtaining a full AFSL.

An applicant who has been granted a restricted licence is able to conduct limited banking business whilst they develop their capabilities and resources in order to meet the prudential standards – the objective of the restricted route is to facilitate entry into the banking sector thus increasing competition whilst ensuring that entry standards are not lessened so as to maintain protections for Australian consumers.

What is involved in practical terms then for seeking authorisation under the ‘restricted route’?

As noted above, the purpose of the restricted licence is to enable competition within the banking sector but in a controlled manner which does not come at the cost of appropriate safeguards to the Australian public. The very nature of the restricted licence means that a less onerous application and capability requirements are imposed on an applicant – but for a limited period of time – two years, after which they must be able to other satisfy the prudential framework requirements. So let’s have a closer look at that licence application process and evaluate the lower standard of requirements.

The first step is to engage early with APRA’s licensing team and organise a meeting with them to discuss the concept that you have and to better understand from their perspective what it is that you are required to do as part of the restricted licence application process. The types of things that APRA will want to see from you at this meeting include: business plans, corporate structure and owner details, corporate governance frameworks, how you propose to fund your bank (where is the investment coming from) and a project plan. (Forming a Bank – Step One – Meet with APRA)

The next step is to submit your business plan to APRA for their high-level review and feedback. It is during this phase that APRA will address any prudential concerns it may hold with the applicant and it should be seen as a pre-licence application test run if anything, a way for the applicant to actively seek out feedback which may concern APRA. The feedback phase may involve multiple sections within APRA meeting with the applicant and raising issues. It is from here that the applicant is to reflect on the feedback provided via APRA’s meeting channels and evaluate their application at that point – be that not to continue or to enhance the current draft application to address any flags that APRA cues with the applicant pre-application. (Forming a Bank – Step Two – Seek APRA’s formal feedback on your business plan)

You’ve met with APRA, you’ve been through the feedback process and now you have your application in good order and are ready to lodge it. The next step is to pay the application fee and lodge your application – the current fee for a banking licence – direct or restricted route – is $80,000 AUD and is payable upon lodgement. The legislative instrument that sets out the applicable filing fees being the Australian Prudential Regulatory Authority Instrument Fixing Charges No 1 of 2013 . (Forming a Bank – Step 3 – Pay the Licence Application Fee on Lodgement)

APRA’s current advice is that it will take between 3 to 18 months to assess an application for a banking licence. In the application assessment phase, you can expect that an allocated APRA case manager, from their licensing group, will be in contact with you in regards to further requisitions they may have. The key matters that APRA will need to be confident that an applicant can satisfy are:

• financial soundness;
• the ability to manage risk effectively;
• the fit and proper expectations for key persons;
• a sound risk culture – both conduct and financial;
• the ability to satisfy prudential requirements;
• public protection – that the applicant does not pose a risk to the safety of the depositors’ funds or the stability of the financial system.

Compliance Quarter has extensive experience and expertise in managing licence applications in complex regulatory environments. If you would be interested in discussing how we may be able to assist you in applying for a restricted banking licence, we would be pleased to arrange a consultation with you – click here to contact us.