I’m very pleased to be here this evening to talk to you about the new regulatory arrangements for the Australian financial system that the Commonwealth Government put in place in the middle of last year.
I am somewhat surprised, however, at the implication in the title I was given that there is something very difficult about finding one’s way around – or should I say through – these arrangements. In principle, it’s quite simple!
The new arrangements are based on what the 1997 Financial System Inquiry (Wallis Committee) called a "functional model" of financial regulation. By this, it meant having one agency responsible for each of the main kinds of regulation applied to the financial system. Each form of regulation is directed at redressing a particular instance of market failure.
In practice, this model has translated into:
- an agency responsible for prudential regulation – which aims, in simple terms, to reduce the risk of institutional failure – this agency is APRA, the Australian Prudential Regulation Authority;
- an agency to promote and regulate for appropriate standards of market conduct by financial institutions, including disclosure standards and consumer protection – the Australian Securities and Investments Commission;
- an agency responsible for protecting the soundness and stability of the financial system as a whole (including the payments system) – this role, of course, lies with the Reserve Bank of Australia; and
- an agency to protect competition in the financial system – this falls to the Australian Competition and Consumer Commission as part of its economy-wide brief for competition.
This arrangement differs from what went before in several respects:
- Prudential regulation had been dispersed among several agencies, each responsible for one or two particular groups of financial institutions – the Reserve Bank for the banks, the Insurance and Superannuation Commission for insurers and superannuation funds, and authorities in each State for the smaller deposit-takers (building societies and credit unions) and friendly societies. (In fact, the latter system is still in place, but change is proposed for later in the year.)
- Those regulators were responsible not only for prudential regulation, but also for some - not all – aspects of consumer protection, such as monitoring compliance with codes of practice and overseeing industry-based complaints resolution schemes.
- Consequently, responsibility for consumer protection was quite fragmented. This was increasingly inefficient as conglomerate groups had entities cross-selling products and services supplied by other parts of the group. Another problem was that similar products and services had become subject to rather different consumer protection regimes simply because they were regulated by different agencies. (The clearest example was the different licensing and disclosure regimes which applied to funds management products depending on whether they were superannuation-related or not.)
- Prudential regulation of similar activities was also fragmented and different agencies oversaw different parts of conglomerate groups.
Some of the problems of uneven treatment of similar products and activities arising from this structure could, in principle, have been resolved in time through cooperation and a determined program of harmonisation among the agencies, which all fall within the Treasurer’s ambit. But in stable conditions such change tends to be slow and modest, and it was felt that rationalisation was more likely to be achieved by bringing like regulatory functions for different institutional groups together.
Achieving the new functional model required the following main changes in legislation:
- the Banking Act was amended to encompass all deposit-taking institutions, not only the banks, and to provide for the licensing and prudential regulation of non-operating holding companies that own a deposit-taker.
- legislation administered by the old Insurance and Superannuation Commission was divided into provisions with a prudential supervision objective and those with a consumer protection/disclosure focus. The main laws involved were the Life Insurance Act, the Insurance Act, the Insurance Acquisitions & Takeovers Act, the Insurance Brokers and Agents Act, the Insurance Contracts Act, the Superannuation Industry (Supervision) Act and its Regulations, and the Retirement Savings Account Act.
- APRA was created to administer the Banking Act and the prudential regulation aspects of the various insurance and superannuation laws. The Life Insurance Act is to be amended to provide for APRA’s supervision of friendly societies when the States pass responsibility for them to the Commonwealth.
- the ASC acquired those consumer protection functions previously carried out by the ISC and the Reserve Bank (which, in the latter case, had not been embodied in legislation), as well as the consumer responsibilities of the ACCC in relation to the financial system. In recognition of its wider responsibilities, the ASC was re-badged as the ASIC.
In addition, a new law – the Payment Systems (Regulation) Act – clarified and strengthened the Reserve Bank’s powers to promote the safety of the payments system. It also gives the Bank power to make directions in relation to competition in the payments system – where exercised, these would have precedence over the powers over the ACCC. A Payments System Board of the RBA has been established to determine the Bank’s policies.
Since APRA is the only genuinely new agency in the new framework – and the one I know most about – I will spend a little time on it; then talk about relationships among the agencies.
Our Charter in the APRA Act says: APRA is established "for the purpose of regulating bodies in the financial sector in accordance with other laws of the Commonwealth that provide for prudential regulation or for retirement income standards, and for developing policy to be applied in performing that regulatory role".
APRA’s objective is to promote prudent behaviour by financial institutions so as to reduce the likelihood that they will become insolvent and unable to meet their obligations to their depositors, policyholders or members, as the case may be.
We are vitally interested in how well financial institutions are managing the risks in their business, and whether they have enough capital to protect against unexpected losses.
Of course, there is no way of absolutely guaranteeing against serious problems developing in regulated institutions. So, in addition to its powers to prescribe standards for prudential behaviour, APRA has extensive powers to intervene in and resolve the position of a financial institution that has become unviable or seems likely to become so.
APRA’s powers in these areas are much the same as those of its predecessor in the case of insurance and superannuation, but they have been significantly clarified and strengthened in respect of banks.* Proposed amendments to the Life Insurance Act would give APRA stronger powers of direction over troubled institutions on the model of the amended Banking Act.
The report of the Financial System Inquiry recommended that APRA should have operational autonomy, with a considerable degree of separation from Government; should be funded on a cost-recovery basis by regulated industry; and should be fully accountable for its performance. The Australian Prudential Regulation Authority Act 1998 is concerned primarily with specifying the structure and administration of APRA in line with these principles.
The Act establishes APRA as an independent authority subject to the Commonwealth Authorities and Companies Act. Its policy and administration is the responsibility of a Board comprising an independent chairperson, the Chief Executive Officer, two representatives of the Reserve Bank, a representative of ASIC and four other "independents". Board members cannot be directors, officers or employees of any agency regulated by APRA. Such a Board promotes coordination among the regulatory agencies whose interests are most likely to overlap, while also providing for non-official input to the setting and conduct of prudential supervision.
Ultimately, of course, APRA is accountable to the Government. To this end, our Act requires the Board to inform the Government of APRA’s policies. Should the Government disagree with those policies, the Treasurer may recommend that the Governor-General, acting with the advice of the Federal Executive Council, issue an order determining the policy to be adopted by APRA. If this happens, the Treasurer is required to inform the Board that the Government takes full responsibility for adoption of the policy. The Treasurer must also table the relevant documents in Parliament. These arrangements provide for transparency and accountability in policy-making and are similar to those applying to the Reserve Bank’s conduct of monetary policy. (APRA must also "advise the Treasurer as soon as practicable if it considers that a body regulated by APRA is in financial difficulty.")
We will also, of course, produce an Annual Report and appear before Standing Committees of both the Senate and House of Representatives.
Another channel of accountability is via consultation with industry about our proposed levies each year, and the requirement that these be approved ultimately by the Treasurer. APRA is entirely funded by levies or fees on regulated institutions.
It is important to note that, as well as charging us with prudential regulation, our Act goes on to say that, in undertaking these functions, APRA is required to "balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality".
Our remit is, therefore, not one purely of financial safety – it is qualified by the need to pay regard to other objectives of public policy. This is one of the reasons APRA needs to be aware of the activities and policies of the other regulatory agencies, and to have sound relationships with them.
I want now to touch on some aspects of those relationships – this will help to illustrate that, while the functional allocation of responsibilities is clear enough in principle, it is often blurred at the edges in practice. A good deal of cooperation is needed if the new arrangements are to work effectively.
APRA and the RBA
There are numerous overlaps in the interests of the RBA and APRA – hardly surprising when APRA is responsible for promoting the health of financial institutions and the RBA is concerned with the stability of the financial system and the economy which that system supports. In recognition of this, the RBA has two senior representatives on APRA’s Board of nine.
When a bank or other financial institution regulated by APRA gets into difficulty there are several courses of action open to us – investigation, restrictions on its activities, replacement of management, appointment of an administrator, seeking liquidation. But if an institution is suffering liquidity problems because of ill-informed market comment leading to loss of confidence by creditors (and potential creditors), the best remedy may be a temporary injection of funds.
This, however, poses a dilemma for APRA - the well-informed regulator - because it has no such funds at its disposal. The RBA, on the other hand, is a bank with a liquid balance sheet and could be a helpful lender of last resort. But it does not have the detailed information needed to assess whether this institution has only a temporary liquidity problem, or is actually insolvent. Clearly, it would need to rely on APRA’s assessment in deciding whether to make public funds available.
This will depend on a degree of trust and confidence in APRA’s judgment – trust developed over time on the basis of shared information, personal contact, and planning on how crisis situations will be managed.
A high-level Memorandum of Understanding sets out basic principles of cooperation between APRA and the RBA. It says, in part, "If either the RBA or APRA identifies a situation which it considers is likely to threaten the stability of the financial system, it will inform the other as a matter of urgency. Responses to a disturbance of this type will depend on the particular circumstances prevailing, but in all cases the RBA and APRA will keep each other informed of their on-going assessment and will consult closely on proposed actions. The RBA will be responsible for determining whether, and how, it might provide emergency liquidity support to the financial system. It does not see its balance sheet as available to support the solvency of an individual financial institution in difficulty.
To foster the necessary understanding and trust at working level, a high-level APRA/RBA coordination committee meets regularly to discuss trends in the financial system, weaknesses among financial institutions and so on. This is a two-way relationship, which is important not only in times of crisis. APRA’s intelligence on the state of the financial system is useful to the RBA’s assessment of the impact of its monetary policy on the economy, while the RBA’s reading of economic trends helps APRA to anticipate changes in banks’ and insurers’ asset quality.
A particular point of common interest is the payments system. The RBA is the regulator of the payments system, while APRA regulates most of the participants in that system. The RBA has a close interest in the health of APRA’s constituents because of the damage to others that can flow through payments linkages. On the other hand, weakness in a bank can first become evident in the payments system – indications which would be of keen interest to APRA.
APRA and ASIC
The common interests of APRA and ASIC are recognised in ASIC’s place on the APRA Board, a Memorandum of Understanding and a high-level coordination committee similar to the APRA/RBA one.
This committee is responsible for "ensuring the appropriate arrangements are in place for matters such as coordinating information-sharing, joint inspections or task forces, referral of cases and enforcement action or major supervisory intervention."
Our routine common interests are probably greatest in the superannuation field. As already noted, APRA administers the bulk of the Superannuation Industry (Supervision) Act and its Regulations, but some important aspects have gone to ASIC - the provisions dealing with disclosure of information to fund members and other "consumer protection" issues, including administration of the Superannuation Complaints Tribunal.
There can be overlap in these interests. Member complaints about the information provided by their fund, the timeliness of advice or the processing of payments can often indicate governance weaknesses which flash red lights for APRA about the prudent management of member funds. Consequently, we have arrangements to ensure that information on complaints is shared efficiently with ASIC.
Moreover, while APRA is responsible for approving trustees who wish to operate public offer funds or pooled superannuation trusts, ASIC is responsible under Corporations Law for issuing licences to intermediaries that deal in, or advise on, superannuation interests. To avoid inefficient duplication of effort, it’s been arranged that when APRA is processing an application for approved trustee status to run a public offer super fund it will include a dealers licence application package from ASIC.
Under the Managed Investments Act, ASIC is responsible for issuing licences to single responsible entities (SREs), which are often also existing or prospective approved trustees of superannuation funds. We are working with ASIC to harmonise, as far as possible, the respective licensing requirements. We are also planning regular meetings to consider licence applications from the same entities and to conduct joint surveillance visits.
The MOU provides for the exchange of information between the agencies where that would assist in carrying out their responsibilities. Such exchange could be particularly important when a regulated financial institution is in difficulty or, for one reason or another, likely to have an impact on conditions in markets where ASIC has an interest. Data on market transactions available to ASIC could contain useful information on the financial soundness of market participants.
We recognise that there will be problem situations where enforcement action is warranted and we will need to determine which of APRA or ASIC should undertake this action to achieve the best outcome. The coordination committee provides the mechanism for determining this, but we are also organising joint enforcement training for staff in both agencies.
There may occasionally be tensions between APRA’s and ASIC’s priorities when a regulated financial institution incurs losses or otherwise becomes exposed to serious weakening in its health. Particularly in the case of banks and other deposit-takers that are vulnerable to a loss of public confidence, APRA may prefer to work behind the scenes with the institution to resolve its difficulties. (Such action can include arranging a merger with a stronger party, otherwise securing an injection of capital or limiting its activities for a time.) On the other hand, one of ASIC’s key interests is in transparency and a well-informed market.
I do not believe that there are any easy or general solutions to such tensions. How they are sorted out will depend on both the circumstances of individual cases and the presence of goodwill and cooperation between the two agencies.
RBA and the ACCC
Let me detour briefly from APRA’s interests to the roles of the Reserve Bank and ACCC in the payments system. Both have responsibilities in this area – the ACCC through its general powers under the Trade Practices Act and the RBA with specific responsibilities under the new payments legislation.
Under its adjudication role, the ACCC may grant immunity from court action for certain anti-competitive practices where it judges that those practices are, on balance, in the public interest. It can also accept undertakings regarding third party access to essential facilities.
The RBA may designate a payments system as being subject to its powers and may then, following public consultation, impose an access regime on that system and/or determine standards for the operation of that system. Where the RBA has done this, members of the system will not be at risk of action under the Trade Practices Act for complying with the Bank’s requirements.
The ACCC retains responsibility for competition and access, except where the RBA has set an access regime or standards.
Clearly, it will be important for the two agencies to be aware of the other’s policies and intentions and to consult on issues of common interest. Arrangements are in place for this purpose.
APRA and the ACCC
There is not a significant overlap between APRA’s responsibilities and those of the ACCC but they will, from to time, need to be considered together.
For instance, APRA will have powers under proposed Commonwealth legislation to mandate a transfer of assets and liabilities from a weak institution to a healthier one. This is a prudential supervision tool that the State supervisory authorities have had in the past, and it has proved very useful for resolving difficult situations quickly. We expect the law will require APRA to take into account relevant provisions of the Trade Practices Act before exercising this power, and to consult with the ACCC whenever it might have an interest in the implications of a transfer of business.
We propose to conclude a Memorandum of Understanding with the ACCC to establish procedures for these circumstances.
The changes to Australia’s financial system regulation are far-reaching. I have been able only to scratch the surface this evening, but I have highlighted the main themes and issues.
*See talk to Monash University Law School Foundation, "APRA - Its Objectives and Powers" Tuesday, 27 October 1998, Melbourne.