Alternative Investment Management Association
John Currie, Maria Polczynski and Sarah Williams
Henry Davis York Lawyers
After what some saw as a slight ‘breather’ during 2005, the pace of regulatory reform in Australia has redoubled during 2006. Many of the reforms will have far-reaching implications for all areas of the financial services industry, and the reforms outlined in this article will impact directly on hedge funds and hedge fund participants who have relevant connections with Australia.
Scope of this article
We shall outline changes in the following areas:
• Anti-Money Laundering and Counter-Terrorism Financing (AML-CTP) legislation;
• Conflicts of Interest policy; and
• Financial Services Reform Act (FSRA) regime refinements.
Anti-Money Laundering and Counter-Terrorism Financing (AML - CTF) legislation
Australia has moved one step closer to implementing the Financial Action Task Force's (FATF's) revised recommendations of June 2003 with the release on 13 July 2006 of a second exposure draft of the Anti Money Laundering and Counter-Terrorism Financing Bill, together with draft AML/CTF Rules.
Australia is implementing the revised FATF 40 recommendations in two tranches. The first will cover financial services and the second will address FATF's "designated non-financial businesses and professions". The Bill therefore focuses on financial services, although with some passing references to casinos, as these two sectors are subject to the current financial transactions reporting laws.
The draft laws impose obligations on "reporting entities". A reporting entity is one that provides any "designated service".
Where the laws apply, the reporting entity has the following key obligations:
• to conduct initial identification of new customers
• to establish and maintain an AML/CTF compliance programme to "identify, mitigate and manage" the risks that a designated service facilitates money laundering or financing of terrorism
• to monitor transactions as part of ongoing due diligence and undertake re verification of identity, if there are circumstances giving rise to an obligation to report a suspect transaction
• to report suspicious transactions, threshold transactions (i.e. over AUD10,000), international and other funds transfer instructions, cross border movements of physical currency and bearer negotiable instruments
• to register as a designated remittance service provider if providing this service otherwise than as a prudentially regulated entity
• to conduct due diligence on correspondent banks and to cease business with any correspondent bank that is identified as a shell bank.
The legislation is stated to be risk-based and achieves this more effectively than its predecessor draft. The level of ML/TF risk against which identification and ongoing obligations are measured must be identified by a reporting entity having regard to its customer types, the types of designated services it provides, its delivery channels, and the foreign jurisdictions with which it deals or in which it operates.
The current Australian financial intelligence unit, AUSTRAC, will be the regulator under the new laws, which confer on AUSTRAC the rule making power to flesh out the statutory requirements for such things as identity verification; suspicious transaction monitoring and reporting, and compliance programs.
The Bill is expected to be enacted this year, with a phased implementation period. Present indications are that the government wants a 12 to 18 month implementation, while industry wants three years. Transitional provisions are yet to be released.
Conflicts of interest policy
As the national regulator having responsibility for the FSRA regime, the Australian Securities and Investments Commission (ASIC) has over the last few years developed detailed policy as to how it expects financial services providers to deal with conflicts of interest. In particular ASIC's Policy Statement 181, issued in August 2004, provided ASIC's approach to how providers should comply with their statutory obligations to manage conflicts of interest.
More practical detail was provided in an ASIC Discussion Paper on managing conflicts of interest released on 19 April 2006. In the Discussion Paper ASIC used hypothetical case studies to explain what is perceived as conflicts of interest and its views on how those conflicts should be managed. The Discussion Paper, number 06-121 is available at www.asic.gov.au. Significantly none of the hypothetical case studies was specifically directed to the hedge funds industry. This is in line with the overall scheme of the Australian legislation and ASIC policy, to the effect that hedge fund managers should be regulated in the same way as conventional fund managers and likewise hedge funds themselves be subject to the same treatment as other funds.
The conflicts of interest issue has recently re-emerged as one of particular interest and concern due to the decision by ASIC in March 2006 to launch civil penalty proceedings in the Federal Court of Australia against Citigroup Global Markets Australia Pty Ltd (Citigroup). Further details can be found at here and Citigroup has denied its wrongdoing.
The Citigroup case has prompted strong criticism of ASIC by industry groups, most prominently the Australian Financial Markets Association (AFMA).
In a submission to the Corporate and Financial Services Regulation Review, AFMA echoed Citigroup's claim that the regulator should have flagged the issues with the investment banking industry. AFMA has said:
"At a minimum we should aim to ensure that the industry as a whole is not taken by surprise by an ASIC policy view…. It is unacceptable that this policy matter is being decided by the courts, before ASIC signalled its policy concerns to the industry, and before there was any discussion with the industry on the implications of ASIC's intended approach."
The hearing of the case, which will probably not occur until calendar 2007, is obviously awaited with great interest.
FSR regime refinements
In our firm's articles in the April and December 2004 editions of the Journal we outlined the effect of the introduction of the FSR regime, its introduction into the Australian body of law as Chapter 7 of the Australian Corporations Act, and the growing range of exemptions available for offshore (i.e non-Australian-resident) financial services providers.
Essentially, the FSRA regime provides a comprehensive legislative regime for the regulation of nearly all financial products and financial services in Australia, and it has a wide extra-territorial net, so that the jurisdiction of the legislation and of the national regulator, ASIC, extends to investment promotion, dealing, advice and market making, and other forms of "financial services business" whether they are undertaken in Australia or offshore.
Over the last 15 months, the Australian Government through the Australian Treasury has undertaken a wide-ranging review of the practical implications of the legislation. As a result the so called FSRA Refinement Program was brought into effect in December 2005.
Briefly the FSRA Refinements bring about the following changes:
• Introduction of Consolidated Financial Services Guide (FSG). The FSG is the disclosure document required to be given to retail investors which discloses the financial services business of the provider and comprehensive cost fee and commission information. An FSG may now be tailored to a specific financial service or product. This refinement will be useful to Licensees with more than one channel of product or service distribution.
• Introduction of short-form Product Disclosure Statement (PDS). The PDS is the disclosure document required to be given to retail investors which describes the characteristics of the financial product offered, including risks involved in the product, benefits, costs and returns and other significant characteristics of the product. It will be possible to use a PDS which will contain only "core" product information. The regulations have not defined "core". However, presumably this would include the a description of the product or service and its risks, costs, features, benefits and dollar disclosure which make the bulk of standard PDSs. But there is a catch! Before producing a short-form PDS, Licensees will need to prepare a full PDS to be made available to retail investors when requested. This will mean subjecting both the full and short-form PDS to a due diligence process.
• A wider meaning is now given to "wholesale" or "non-retail" investors which will now include assets or income of trust companies controlled by the investor as well as the assets or income directly controlled by the investor. Additionally, the A$10 million controlled assets threshold for a "professional investor" has been expanded to include A$10 million in "gross assets".
• A broader meaning is given to "general advice" to allow general inquiries about financial products to be made without triggering disclosure or other licensing requirements.
• The jurisdictional reach of Chapter 7 has been limited (slightly). Chapter 7, which contains the FSRA regime, is currently given very extensive extra-territorial effect. Under the Refinements, in some circumstances Licensees will not need to provide disclosure documents where they provide financial services to clients outside Australia. Foreign financial service providers will also be exempt from disclosure requirements in certain circumstances.
• Other refinements have been made to such areas as facilitating consolidation of statements of personal advice, oral disclosure requirements and disclosure requirements for Basic Deposit Products.