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Regulatory Developments – All that you can’t leave behind

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Samantha Hills Senior Associate Linkedin

As you turned the corner into 2020, you might have been grateful to leave the events of 2019 behind you.  But regulatory developments in 2019 will drive the agenda in 2020 and beyond.

We asked our lawyers to name the top developments of 2019.  Here’s what they came up with and why.

Royal Commission

The Royal Commission handed down its Final Report.  The hearings themselves, which occurred in 2018, had already begun to drive significant cultural change in organisations, simply by exposing case studies.

However, the Report included concrete recommendations, many of which the Government has begun to implement.  Among these were:

  • the eradication of grandfathered conflicted remuneration
  • the introduction of a best interests duty for mortgage brokers
  • the removal of conflicted remuneration for mortgage brokers
  • inclusion of insurance claims handling in the definition of “financial service”.

Conflicted remuneration

Product issuers currently paying grandfathered conflicted remuneration will need to rebate this remuneration to product holders from 1 January 2021.  This is thanks to Treasury Laws Amendment (Ending Grandfathered Conflicted Remuneration) Act 2019, which became law in October, and Treasury Laws Amendment (Ending Grandfathered Conflicted Remuneration) Regulations 2019, which were made in November 2019.  AFS licensees which are required to rebate conflicted remuneration will have record-keeping requirements in relation to the remuneration.

This is a significant shift for the industry.  It will have consequences for the income streams (and therefore the value) of many advice practices.  It also signifies a shift from a softly-softly approach to removing conflicts of interest in the financial services industry, to a more explicit approach by the Government.

Life insurance commissions remain permissible under the current regime but for how long?  The Commissioner recommended these be reviewed.  According to the Government’s Restoring Trust in Australia’s Financial System Financial Services Royal Commission Implementation Roadmap August 2019, ASIC will undertake this review in 2021.  The key for proponents of life insurance commissions will be to convince ASIC that the risk of under-insurance is too great if such commissions are removed.  Whether ASIC will buy this is another thing.

Mortgage brokers

In a frenzy of legislation brought before the House of Representatives just prior to the end of 2019, the Government moved to create a best interests duty for mortgage brokers and to force them to prioritise their clients’ interests when providing credit assistance.  The Bill containing these provisions is the Financial Sector Reform (Hayne Royal Commission Response) – Protecting Consumers (2019 Measures)) Bill 2019.

The same Bill provides for regulations to be made which will restrict the circumstances in which conflicted remuneration can be given or received in connection with credit services provided by mortgage brokers and intermediaries.

While the definition of “conflicted remuneration” in financial services licensing is linked to the effect of the remuneration on a recommendation made, it appears that the concept for mortgage brokers will be broader.  T-REX will, of course, report on the progress of this legislation during 2020.

Insurance claims handling

The Government has been consulting in relation to proposed legislation and regulations which would remove the exclusion from the definition of “financial service” which insurance claims handling has enjoyed to date.  If it is efficient in getting the legislation into Parliament and passed and getting the regulations made, the changes are likely to take effect from 1 July 2020.  Many licensees will need to amend their licence authorisations and some people or organisations not currently licensed may need to become authorised representatives or obtain licences.  This is likely to have an enormous effect on consumers’ experiences of claims handling by insurers.

ASIC’s tougher regulatory approach

Also stemming from the Royal Commission is a new approach by ASIC, known as “Why not litigate?”  This approach grew out of the hearings themselves but was cemented by an explicit recommendation by the Commission that ASIC should “[take], as its starting point, the question of whether a court should determine the consequences of a contravention.”

In a recent hearing of the Parliamentary Joint Committee on Corporations and Financial Services, ASIC stated that it was pursuing cases where it has new powers and where there are new penalties available.

New and increased penalties

This new approach by ASIC, coupled with the commencement of civil penalty regimes for breaches of section 912A and section 912D, mean that industry players can no longer treat the obligations under these provisions as minor.  Contravening them could really hurt the bottom line.

Section 912A contains a licensee’s key obligations, such as the need to have adequate risk management systems and (everyone’s new favourite) the need to do all things necessary to provide financial services efficiently, honestly and fairly.  Section 912D, of course, sets out a licensee’s obligation to report a significant breach within 10 business days of identifying it.

As a law firm, we repeatedly observe problems with the ability of licensees to understand precisely how the breach reporting provisions apply – from problems determining at what point a breach is identified by the licensee (which cannot, contrary to the opinion of some licensees, be “engineered” but is, rather, a question of fact) to problems understanding how to determine whether a breach is significant.

The legislation which introduced civil penalties for contraventions of sections 912A and 912D was Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Act 2019.

That legislation also increased penalties for breaches of various other provisions of the Corporations Act 2001.  These increased penalties, as well as the new penalties for breaches of sections 912A and 912D, are likely to have a significant impact on the efforts made by licensees to comply with the law.  When penalties are small, a compliant licensee can suffer an economic disadvantage compared to its non-compliant competitor.  This can tempt compliant licensees to be non-compliant themselves in an effort to keep up with their rivals, causing non-compliance to snowball.

Design, distribution and intervention

In April 2019, Parliament gave ASIC powers to intervene in relation to financial or credit products with a risk of significant detriment to retail clients or consumers.  This legislation was the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019.

The powers commenced later that same month.

The Act also introduced obligations in relation to the design and distribution of products.  These obligations will commence in April 2021.  They aim to prevent products being targeted at clients or consumers to which the products are typically poorly suited.

These obligations were fine-tuned in Corporations Amendment (Design and Distribution Obligations) Regulations 2019, made in December.

The first casualties of ASIC’s product intervention power were short-term credit providers taking advantage of an exemption under the National Consumer Credit Protection Act 2009.  ASIC exercised its power using ASIC Corporations (Product Intervention Order – Short Term Credit) Instrument 2019/917.  The order remains in force for 18 months.

Next, ASIC looked to CFDs and OTC binary options, issuing Consultation Paper 322 Product intervention: OTC binary options and CFDs.  Consultation closed in October.  At the time of writing, ASIC had not yet made an order.

The proposed intervention includes eight conditions for the issue of CFDs, including leverage ratio limits and real-time disclosure of total position size.

The proposed intervention also proposes that licensees not be able to provide binary options to retail clients.

The intervention (if it goes ahead) will have significant impact on the CFDs sector, which has already seen a tightening of regulatory requirements in relation to retail clients over recent years, particularly in relation to client money.

The introduction of intervention powers and design and distribution obligations is a major policy shift towards interference in the free market.

This is part of a broader shift away from a free market economics approach where consumers are expected to make rational decisions in their own self-interests based on perfect information.  The shift is towards a behavioural economics approach.  It places the burden on the financial services industry to protect consumers from products that might not be safe and, in some respects, to protect consumers from themselves.

Whether you view this as good or bad, there is no doubt that it changes the landscape significantly for licensees.

FASEA education and ethics

New education and ethics requirements had a heavy impact on the personal advice sector.

New qualification requirements came into play from 1 January 2019 for new advisers.  From this date, an adviser entering the profession must also do a year of on-the-job training before becoming a fully-fledged adviser.

Existing advisers have until 1 January 2024 to come up to required qualification levels.  Late in 2019, the Government introduced a Bill aiming to extend this deadline to 1 January 2026, Treasury Laws Amendment (2019 Measures No. 3) Bill 2019.

The broad qualification requirements appear in the Corporations Act 2001 and some detail is provided by FASEA in Corporations (Relevant Providers Degrees, Qualifications and Courses Standard) Determinations 2018.

Further detail appeared throughout 2019 in the form of legislative instruments and policies from FASEA.  These include a policy on foreign qualifications: FPS005 Foreign Qualifications Policy.  They also include a document on recognition of prior learning: FASEA Approved Recognition of Prior Learning List.

Continuing professional development requirements for advisers also began from the start of 2019, thanks to earlier changes to the Corporations Act 2001.

Licensees had to begin documenting CPD policies and plans from 31 March.  There was a scramble as licensees sought to get their heads around Corporations (Relevant Providers Continuing Professional Development Standard) Determination 2018, which set out FASEA’s requirements in relation to CPD policies and plans.

In February, FASEA set out the details of the exam for advisers in Corporations (Relevant Providers Exams Standard) Determination 2019.  This exam must be completed by new advisers from 1 January 2019.  Existing advisers have until 1 January 2021 to pass the exam.  Following the introduction of Treasury Laws Amendment (2019 Measures No. 3) Bill 2019, this deadline is likely to change to 1 January 2022.

The exam was rolled out three times towards the end of 2019.  Each roll-out involved different exam questions.  Anecdotal feedback suggests the exam became harder with each roll-out.

Licensees looking for ways to prepare advisers for the exam find the FASEA practice questions useful.  Not so useful is FASEA’s recommendation that advisers read portions of the Corporations Act 2001, as some of this legislation can be impenetrable, even to those with legal training!

In February, FASEA created the Code of Ethics, for which the Corporations Act 2001 provides, in the form of Financial Planners and Advisers Code of Ethics 2019.  Compliance with the code was mandatory for advisers from 1 January 2020.

As 1 January 2020 loomed, industry waited to see what body would be appointed to monitor advisers’ compliance with the Code.  In October, the Government announced that it would not be appointing a Code monitoring body.  Instead, Code monitoring will be handled by the disciplinary body which the Government plans to establish in the wake of a recommendation to do so from the Royal Commission.  The Government expects to establish this body in 2021.

This left the industry in the interesting position where advisers are legally required to comply with the Code but there is no one to monitor or enforce that other than licensees themselves.  The legislative framework allowing for the establishment of a Code monitoring body and for the reporting of breaches of the Code to that body by licensees still sits in the legislation until Parliament gets around to amending it.  In November 2019, ASIC made a legislative instrument exempting licensees from their obligations under that legislative framework: ASIC Corporations (Amendment) Instrument 2019/1145.

Meanwhile, ASIC has warned licensees that they need to make efforts to help advisers comply with the Code in order to comply with the licensee obligation under section 912A to take reasonable steps to ensure that representatives comply with financial services laws.  As is often the case for the general licensee obligations under section 912A, it is difficult to say what steps will be sufficient to satisfy this obligation.

In our view, training and internal audit and monitoring will be essential parts of the licensee’s strategy to meet the obligation in respect of the Code.

AFCA has also said that it will take into account the Code when assessing a complaint about an adviser’s conduct where that conduct occurred post 1 January 2020.

Rendering the job of a licensee even more difficult is the fact that the Code contains a number of ambiguities, some of which were further obfuscated by FASEA’s guidance on the Code, found in FG002 Financial Planners and Advisers Code of Ethics 2019 Guidance which was released in October 2019.  Efforts to rectify this appeared in Preliminary Response to Submissions FG002 Financial Planners and Advisers Code of Ethics 2019 Guidance issued right on the cusp of the Christmas break, on 20 December 2019.

General and personal advice

Those treading the line between general and personal advice were most interested in the judgment handed down by the Full Federal Court in Australian Securities and Investments Commission v Westpac Securities Administration Limited [2019] FCAFC 187 in October 2019.

It was the first fully reasoned analysis of the advice distinction by a superior court, with useful analysis of the best interests duty and the efficiently, honestly and fairly obligations.

The case had particular implications for general advice provided in one-on-one situations.

Two Westpac super trustees had written to their members, in each case offering to find out whether the member had holdings with more than one super fund.  After a member accepted this service, and where the Westpac entity found that the member had multiple super holdings, a Westpac representative called the member with the aim of getting them to roll their other super holdings into their Westpac super fund.

It purported to do this on a general advice model.

A single judge of the Federal Court had earlier found that, although this conduct breached the licensee’s “efficiently, honestly and fairy obligation” under section 912A, it did not amount to the provision of personal advice.

The Full Court agreed that the efficiently, honestly and fairly obligation had been breached but overturned the single judge’s finding in relation to personal advice.

They found that the Westpac entities did provide personal advice.  Much of this hinged on the perceptions of a reasonable person in the shoes of the customer in each case.  A number of aspects of the call helped create the impression that the Westpac entity was taking into account things about the customer in each case.

One critical element was the pre-existing relationship between the Westpac entity and the customer.  It was their own super trustee and it conveyed an attitude of helpfulness to the customer, creating an impression that it was acting in the customer’s interests.

Another element was the fact that the representative attempted to get the customer to agree to the roll-over in the course of the telephone call.  This established an impression that the caller had considered the customer’s circumstances sufficiently for action to proceed.

Had the representative encouraged the customer to think about their proposed course of action, ended the call and spoken to the customer on another occasion, this may have made it clearer to the customer that it was the customer’s role to consider their circumstances and that the Westpac entity had not done so.

A further aspect was the significance of the financial product which was the subject of the telephone call: superannuation.  As super is such an important asset, a reasonable person in the shoes of the customer would have expected that the Westpac representative had considered their circumstances when encouraging them to take action.

The decision has significant ramifications for call centres operating on a general advice model and in fact begs the question whether it is even possible for a call centre to operate on this model.  It will be interesting reconciling this question with the fact that ASIC has, over the years, licensed a number of licensees to provide general advice using just such a model.

Interested licensees wait with bated breath to see if the decision will be appealed in the High Court.

Consumer data right

The Treasury Laws Amendment (Consumer Data Right) Act 2019 became law in August 2019.

The first sector in which the consumer data right applies is the banking sector.  Over time, it will be extended to other sectors.

The consumer data right framework is regulated by the ACCC, the OAIC and a new Data Standards Body.

Sector-specific rules are prepared by the ACCC and sector-specific technical standards are prepared by the Data Standards Body.

A holder of a consumer’s data will need to have systems and processes in place to respond to a request from the consumer to transfer their data to a third party.  A recipient of a consumer’s data will need systems and processes which ensure that the data is used in accordance with the terms of the consumer’s consent.

The consumer data right is being introduced into the banking sector in phases, from 1 July 2020 in relation to credit and debit card, deposit account and transaction account data and from 1 November 2020 in relation to mortgage and personal loan data.

This development will have a big impact on competition and triggers the need for systems and processes with adequate capability to accommodate the new regime.

AML/CTF

Westpac continued its rocky end to the year when AUSTRAC announced that it had applied to the Federal Court for civil penalty orders for non-compliance with the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 on over 23 million occasions.

The alleged failures relate to a range of obligations, including the obligation to report internal funds transfer instructions to AUSTRAC.  Of great interest to the media and of great public concern was the alleged failure to carry out appropriate due diligence on customers sending money to regions with known child exploitation risk.

Some of the issues behind the failures sound rather like the issues identified by APRA’s report into CBA in May 2018.  It appears that there were failures in Westpac’s culture and control environment, including an indifference by senior management, inadequate oversight by the Board and a failure to address known compliance issues in a timely manner.

Having come through the Royal Commission relatively unscathed, Westpac’s CEO, Brian Hartzer, and Chairman, Lindsay Maxsted, fell on their swords.

With each contravention of the law theoretically capable of attracting a fine of $17 million to $21 million (depending on the obligation contravened), Westpac risks facing a fine greater than that imposed on CBA in 2018.  At the time, that was the biggest civil penalty in Australian corporate history.

This case is a reminder of two important points.  First, your systems are everything.  A single flaw in a system can result in millions of breaches, as transactions or other actions flow through that system.  The move to highly automated systems in recent years magnifies this problem significantly.  In this respect, technology is a double-edged sword.  This issue applies for compliance in a multitude of areas, not just in AML/CTF.  For example, derivative trade reporting also relies heavily on the quality of systems in place to meet the relevant obligations.

Increasingly, licensees will need compliance personnel who are innovative and tech-savvy or, at least, who can communicate effectively with technology experts.  This will help them build systems capable of coping with today’s regulatory requirements.

Second, strong reporting lines, governance and accountability are fundamental to an organisation meeting its regulatory obligations.

The media reported Mr Hartzer as saying that he had only become aware of the allegations regarding child sex exploitation a month before AUSTRAC brought the proceedings.  This is interesting given that AUSTRAC said, in its concise statement to the Court:

Since at least 2013, Westpac was aware of the heightened child exploitation risks associated with frequent low value payments to the Philippines and South East Asia, both from AUSTRAC guidance and its own risk assessments.

Organisations will need to continue to consider how best to report effectively to senior management and the Board without subjecting them to information overload.

APRA announced its own investigation into possible breaches by Westpac of the Banking Act 1959 (including the Banking Executive Accountability Regime) and APRA’s prudential standards stemming from conduct surrounding the alleged AML/CTF breaches.

There will no doubt be many lessons to learn from the AUSTRAC proceedings and APRA’s investigations as they unfold in 2020.

Author: Sam Hills, Senior Associate