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Bills Digest No. 184  1997-98
Financial Sector (Shareholdings) Bill 1998

WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

CONTENTS

Passage History
Purpose
Background
Main Provisions
Concluding Comments
Endnotes
Contact Officer and Copyright Details

Passage History

Financial Sector (Shareholdings) Bill 1998

Date Introduced: 26 March 1998

House: House of Representatives

Portfolio: Treasury

Commencement: The Act cited as the Financial Sector (Shareholdings) Act 1998 commences on the commencement of the Australian Prudential Regulation Authority Act 1998. The latter Act commences on the day it is proclaimed, but that must be within six months of Royal Assent.(1)

Purpose

This Bill is one of a package of Bills(2) to implement the Government's response to the recommendations of the Financial System Inquiry (the FSI) in its report the FSI report.(3) The object of this Bill is to regulate the ownership and acquisition of prudentially regulated financial institutions in accordance with the recommendation in the FSI Report, subject to the changes referred to in this Bills Digest.(4) The financial institutions, referred to as financial sector companies (FSCs) in the Bill, will be:

(a) any authorised deposit taking institution as defined in the Banking Act 1959;

(b) any insurance company authorised under the Insurance Act 1973;

(c) a company registered under the Life Insurance Act 1995;and

(d) a holding company of a company covered by paragraphs (a) or (b) or (c).

The Bill seeks to ensure that the financial health of a prudentially regulated financial institution is not affected by the adverse fortunes of any particular individual person and or their associates. This will be achieved by placing restrictions on shareholdings in financial sector companies.

As indicated in the simplified outline of the Bill, in proposed section 8, the following measures are included in the Bill to restrict shareholdings:

• 'Financial sector companies are subject to a 15% shareholding limit. The Treasurer may approve a higher percentage limit on national interest grounds;
• Those limits relate to a person's stake in a company;
• A person's stake is the aggregate of the person's voting power and the voting power of the person's associates;
• A person whose stake in a financial sector company does not exceed 15% may be declared by the Treasurer to have practical control of the company;
• The person covered by the declaration must take steps to ensure that the person does not have:

       a) a stake that exceeds 15%; or

       b) practical control; and

• The regulations may require records to be kept, and information to be given, for purposes relating to the restrictions on shareholdings.'

A key recommendation of the FSI was that the existing institutionally based system of prudential regulation should be combined in a single agency at the Commonwealth level to be called the Australian Prudential Regulation Commission (APRC). The Australian Prudential Regulation Authority Bill 1998, which was introduced at the same time as this Bill and which seeks to establish the Australian Prudential Regulation Authority (APRA), implements this recommendation.(5)

Background

The Financial System Inquiry and the philosophy underpinning prudential regulation

The Wallis Committee was set up to stocktake the results of financial deregulation of the Australian financial system since the early 1980's, to establish a common regulatory framework for overlapping financial products and to propose ways of dealing with further financial innovation.

The Final Report of the Financial System Inquiry (FSI), chaired by Mr Stan Wallis (President of the Business Council of Australia), was released in April 1997. A number of recommendations were made to intensify competition and efficiency in the financial system, including recommendations for substantially streamlined regulatory arrangements.

In response to the FSI Report, the Treasurer announced that the Government intends to institute a wide-ranging set of financial system reforms.

The FSI took the view that Government intervention in the form of prudential regulation should only provide an added level of financial safety beyond that provided by conduct and disclosure regulation. Further, the intensity of prudential regulation should be proportional to the degree of market failure which it addresses, but it should not involve a government guarantee of any part of the financial system.(6)

Financial safety, whilst being fundamental to the smooth operation of the economy has an inherent risk component. The FSI observed that risk is an essential component of any financial system and, in an efficient system, is priced to reward those who bear it. Prudential regulation is preventative in nature in that it is directed at preventing breaches of financial promises through financial failure. Ultimately, it is the responsibility of the management and the board of a financial institution to deliver on the promises made, and it is not appropriate for government to underwrite them. The framework and approach to prudential regulation in the FSI Report is underpinned by these philosophical considerations.(7)

With respect to the payments system, the Government accepted the Committees' recommendations. Of special relevance to banking law, the Committee recommended the formation of a Payments System Board under the control of the Reserve Bank of Australia (RBA) to regulate the payments system; liberalisation of access to the clearing system; regulation of stored value cards; and laws to allow for electronic commerce. The Payment Systems (Regulation) Bill 1998 details the proposed new regulatory framework for the payments system, which is being introduced consistent with the recommendations of the FSI.

Amendments to the Reserve Bank Act 1959, as provided for in the Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998, provide for the creation of the Payments System Board (PSB) within the RBA to provide for policy making in relation to the payments system and to increase the accountability of the RBA in relation to its role in the payments system.

The need to spread ownership of Deposit Taking Institutions (DTIs)

The FSI Report records that a regulatory regime which ensures spread of ownership of a financial institution, which is a deposit taking institution (DTIs), protects the institution from the adverse circumstances of a major shareholder. It provides assurance that the financial system is saved the contagion effect by association, should one institution collapse, due to the circumstances of a major shareholder. As the FSI Report notes: (8)

• Spread of ownership protects institutions against undue influence by a major shareholder and creates a broad interest group in the shareholder base. The FSI considered that the concept has sufficient weight to justify the continued application of the spread of ownership objective as a general principle for DTIs. The case is much weaker for insurance companies, which are less susceptible to contagion effects.
• The Inquiry considered that the arrangements would be simplified by a single threshold test. It favoured a single rule of 15 per cent which is the level that applies under the regulation of foreign investment. Replacing the various acts and rules with a single Acquisitions Act covering all DTIs and insurance companies would streamline administration and remove some of the inappropriate perceptions of the 'specialness' of financial entities. Exemption for existing licence holders should be determined by the APRC (even where the licence is held by an entity in the same group).
• Approval for foreign ownership or ownership by non-financial entities above this limit should be determined by the Treasurer (rather than the Governor-General), giving consideration to the prudential regulator's advice on prudential matters, such as 'fit and proper' person tests and ability to meet prudential standards on a continuing basis.
• Giving power of approval to the APRC would facilitate more efficient processing of applications for ownership exemptions. All acquisitions would remain subject to competition regulation, and takeovers of a public company would remain subject to regulation under the Corporations Law. Other requests for exemption would be relatively infrequent and should be determined by the Treasurer (or APRC under delegation from the Treasurer), applying a national interest test.

The need for a single threshold test will be appreciated when the different limits set by the Banks (Shareholdings) Act 1972 (Cth), Insurance Acquisitions and Takeovers Act 1991 (Cth) and the Financial Institutions Code 1992 (FI Code) are considered.(9) The different rules as summarised in the FSI Report, are set out below:

• The Banks (Shareholdings) Act 1972 places a general limit on shareholdings in banks of 10 per cent of voting shares. The Treasurer may provide exemptions up to 15 per cent and the Governor-General may provide an exemption up to any higher level if this is considered to be in the national interest. To date, the higher exemptions have mostly been applied to allow bank (or life company) acquisitions of banks, or to allow foreign banks to establish wholly owned subsidiaries in Australia.
• The Insurance Acquisitions and Takeovers Act 1991 provides that, where share acquisitions or issues would result in a controlling interest of more than 15 per cent, the Treasurer must be notified. The Treasurer then has 30 days to provide a conditional or unconditional approval or to issue a restraining order.[ A footnote states that in practice, many acquisitions are authorised by the Insurance and Superannuation Commission under a delegation from the Treasurer].
• The FI Code imposes on building societies and potentially other institutions under the FI Scheme, a general maximum shareholding limit of 10 per cent of any class of shares but provides for exemptions in accordance with standards issued by AFIC. The basic tenet of the standards is that exemptions will be granted only for 100 per cent ownership by a conglomerate which can satisfy a test as to spread of ownership of the ultimate holding entity.(10)

The FSI Report Recommendation 45 concluded that the principle of spread of ownership should be retained and regulation rationalised to impose a common 15 per cent limit. To quote the FSI Report again:

• The APRC should have power to approve, subject to prudential requirements,
  an exemption allowing a licence holder to acquire more than 15 per cent of a
  licensed institution; and
• Any other person may acquire more than 15 per cent of a licensed institution
  only if the Treasurer approves the acquisition in the national interest.(11)

Main Provisions

15 per cent shareholding limit

Division 2 of Part 2 of the Bill provides the mechanism for limiting shareholdings in a financial sector company (FSC) to 15 per cent or such higher percentage as may be approved by the Treasurer under Division 3 of Part 2. Proposed section 10 gives the meaning of an 'unacceptable shareholding situation', which arises where a person's stake in a financial sector company is more than 15% or such higher percentage approved under Division 3. A note to proposed section 10 states that a person's stake includes the interests of the person's associates. Schedule 1 to the Bill is titled - Ownership definitions - and includes the definition of terms relating to the ownership of shares, interest in a share, associates, voting power, stake in a company and direct control interests in a company.

'Stake in a FSC', as defined in proposed clause 10 of Schedule 1 to the Bill, is the aggregate of the direct control interests of a person and that person's associates in the company.

The term associates is given a wide definition in proposed clause 4 of Schedule 1. It includes a relative, a partner, a company in which that person is an officer, a trustee of a discretionary trust where the person or an associate is capable of benefiting under the trust either directly or indirectly through any interposed companies, partnerships or trusts. The definition of associates also includes a company whose directors are accustomed to act in accordance with the directions of the person, a company where the person would apart from proposed paragraph 4(1)(j) have a stake of not less than 15%. Further, if the person is a company - a person who holds, apart from proposed paragraph 4(1)(k), a stake in the company of not less than 15% is an associate.

The Banks (Shareholdings) Act 1972 (Cth) which places a limit of 10 percent on bank shareholdings will be repealed by proposed Schedule 3 of the Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998. Part 2 of the Insurance Acquisitions and Takeovers Act 1991 (Cth) which places a limit of 15 per cent on shareholdings in insurance companies will be repealed by measures in proposed Schedule 8 of the Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998.(12)

Approval by Treasurer to exceed 15% shareholding limit

The Bill gives the Treasurer power under Division 3 of Part 2 to approve the acquisition of more than 15 per cent in a financial sector company (FSC) subject to a national interest test. Proposed section 13 allows a person to apply to the Treasurer for approval to hold a stake in a FSC of more than 15 per cent. Proposed subsection 14(1) provides that the Treasurer may grant the application if the applicant satisfies the Treasurer that it is in the national interest to approve the application. The approval may specify the period during which the higher shareholding limit applies and, if no such period is specified by the Treasurer under proposed subsection 15(1), the approval applies indefinitely. The Treasurer may grant such approval subject to conditions which are specified in the notice of approval under proposed subsection 16(1). However, proposed subsection 17(6) provides that the Treasurer may vary the percentage specified in any approval if the Treasurer is satisfied that it is in the national interest to do so.

Any approval given to a person to hold a stake exceeding 15% in a FSC, extends to all the companies that are 100% subsidiaries of that FSC.

The Treasurer may under proposed subsection 18(1), by written notice, revoke an approval if satisfied that it is in the national interest to do so, or if an unacceptable shareholding situation exists or there has been a contravention of a condition of approval. The holder of an approval may also request that the Treasurer make a revocation. A revocation takes effect on a date specified in the notice which must not be less than 90 days from the date on which notice is given.

Copies of notices of approvals, extensions, variations and revocations made by the Treasurer must be published in the Gazette and given to the FSC.

Practical control where 15% shareholding limit not exceeded

Division 4 of Part 2 of the Bill provides that the Treasurer may declare that a person has practical control of a FSC, even though that person does not have a stake in the FSC or has a stake less than 15%.

Proposed section 22 states that control includes control as a result of, or by means of, trusts, agreements, arrangements, understandings and practices, whether or not having legal or equitable force and whether or not bases on legal and equitable rights.

Proposed subsection 23(1) provides that the Treasurer may make a declaration that a person has 'practical control' of a FSC, if the Treasurer is satisfied that:

• the directors of the FSC, or the company itself are subject to the directions, instructions or wishes of a person either alone or with associates; and
• that person alone (or with associates) has not more than a 15 per cent stake in the FSC; and
• it is in the national interest to make the declaration.

Proposed section 24 titled - Requirement to relinquish practical control or reduce stake - provides that a person who is declared by the Treasurer to have practical control must relinquish practical control by a variety of means including by reducing their stake in the FSC. However, as will be seen from the terms of proposed subsection 24(1), there is an ambiguity in regard to the availability of the option to reduce the person's stake.

Proposed subsection 24(1) requires a person declared to have practical control of a FSC to take steps to ensure that:

1. the directors of the FSC no longer act in accordance with the directions, instructions or wishes of the person either alone or together with associates (proposed paragraph 24(1)(a); and
2. the person is not in a position to exercise control (proposed paragraph 24(1)(b); and
3. either:

• the person does not have any stake in the company (proposed subparagraph 24(1)(c)(i); or
• if the person has a stake in the company - that stake is not more than 15% (proposed subparagraph 24(1)(c)(ii)).

To comply with the these provisions a person declared to have practical control must take steps that ensure that practical control no longer exists in the manner described in proposed paragraphs 24(1)(a) and (b). As the person declared to have practical control may have a stake in the FSC, which is not more than 15 per cent, the person could comply with the requirement of proposed paragraph 24(1)(c) by:

• either completely divesting himself or herself of the entire stake in the FSC and fall within the terms of proposed subparagraph 24(1)(c)(i); or
• by reducing the stake of that person still further from the percentage held previously.

There is an ambiguity in the terms of proposed subparagraph 24(1)(c)(ii) as it does not specifically state that a further reduction in the stake may be required. In the absence of this requirement proposed paragraph 24(1)(c) may have no particular effect, because the person affected by the declaration must have already complied with the requirements of proposed subparagraph 24(1)(c)(ii) or proposed subparagraph 24(1)(c)(i) at the time the Treasurer made the declaration.

This same ambiguity exists in proposed subparagraph 25(1)(f)(ii) relating to the remedial orders which the Federal Court is authorised to make on the application of the Treasurer, where the Treasurer has made a declaration of practical control.

Remedial Orders and Paragraph 51(xxxi) of the Constitution

The Bill provides for the Treasurer to make application to the Federal Court for remedial orders if an unacceptable shareholding situation exists under Division 2 (proposed section 12), or if a declaration of practical control has been made by the Treasurer under Division 4 (proposed section 25). The Federal Court's orders may include:

Proposed section 30 provides that the Federal Court must not make an order, if the order would result in the acquisition of property from a person on terms that would not be just, or would be invalid because of paragraph 51(xxxi) of the Constitution. This provision reflects recent authority of the High Court. A number of principles have emerged on the interpretation of paragraph 51(xxxi), following the decisions in five cases handed down by the High Court in 1994: Mutual Pools,(13) Peverill(14), Georgiadis,(15) Lawler(16) and Nintendo(17). The Attorney-General's Legal Practice Briefing No. 13 of 28 July 1994 examined the developments in the interpretation of section 51(xxxi) in those cases against the pronouncements of the High Court in the earlier cases and concluded rightly that 'just terms' involved full monetary compensation, as opposed to fair compensation as had been perceived from the earlier cases. To quote the Practice Note:

The cases produced little discussion on 'just terms'. The Commonwealth had argued that 'just terms' did not necessarily involve full monetary compensation but involved general notions of fairness, and that a range of factors could be considered. Only Brennan J considered these arguments. He rejected them: in his view section 51(xxxi) is a guarantee that, when property is acquired in the circumstances to which the provision applies, the burden will be borne by the taxpayers (or, possibly, the person acquiring the property) and not by the individual whose property is confiscated. This appears to be a more restrictive view than had been put in statements in some earlier cases, which suggested that there might be circumstances in which compensation at less than full value of the property could be 'just'(18).

Prior to the 1994 cases, the High Court had held that 'acquisition' and 'property' in paragraph 51(xxxi) must be construed liberally and not to be confined pedantically to the taking of title to some specific estate or interest in land recognised at law or in equity but extends to innominate and anomalous interests.(19)

'Property' as used in paragraph 51(xxxi) extends to 'every species of valuable right and interest and the right to receive a payment of money including ... choses in action'.(20)

In Newcrest Mining (WA) Ltd v Commonwealth the High Court in 1997 took the view that paragraph 51(xxxi) of the Constitution must be given a meaning and operation that protects the basic rights of corporations and individuals.(21)

A remedial order may therefore amount to an acquisition of property having regard to the loss of rights of the person declared to be involved in an unacceptable shareholding situation or in practical control. It may in addition amount to an acquisition of property in relation to the other shareholders and the FSC which may have been deprived of the right to have a key person in control of the FSC. Thus there may be circumstances where remedial orders may require the payment of compensation by the Commonwealth to ensure compliance with the just terms requirement in paragraph 51(xxxi) of the Constitution, which has been reiterated in proposed section 30.

Depositors in a FSC may be expected to place their confidence in an FSC based on their own assessment of the capabilities of persons holding substantial interests in an FSC as well as the persons in control. If a remedial order, intended to protect depositors generally, results in a change of management or substantial shareholders it may be argued that their rights to deal with a company of their choice has been interfered with to their detriment. Whether such a right is 'property' is doubtful based on the 1994 decision of the High Court in Nintendo.(22) This case concerned the sale by Centronics Systems Pty Ltd (Centronics) of video games imported from the Nintendo Co Ltd of Taiwan. It was claimed that the practical effect of the operation of the Circuit Layouts Act 1989 (Cth) constituted an infringement of intellectual property rights of the Nintendo Co. Ltd. In the High Court, Centronics argued that the impact of this legislation on their previous commercial operation amounted to an 'acquisition of property' entitling them to 'just terms.'

Will decisions on control and stakes in a FSC based on the National Interest Test attract Crown Liability to Depositors?

It will be seen that the ability to restrict shareholdings of a person and that person's associates in a FSC to 15% is based on the premise that it is not in the national interest to permit a higher holding generally. Thus the Bill makes exceptions where the Treasurer grants an application from a person to hold a higher stake than 15% where the Treasurer is satisfied that it is in the national interest to approve the applicant. An approval under proposed section 14 may be subject to such conditions as may be specified in the notice of approval and proposed section 16 authorises the Treasurer to impose further conditions or vary or revoke any condition. The conditions imposed by the Treasurer may therefore be expected to be based on national interest considerations. Again, proposed section 17 authorises the Treasurer to vary the percentage holdings of a person which was specified in an approval under proposed section 14 on the Treasurer's own initiative or on the application of the person concerned, if it is in the national interest to do so. Also, proposed section 23 authorises the Treasurer to declare a person to have practical control of a FSC even where that person does not have a stake in the FSC, if the Treasurer is satisfied that the directors act in accordance with the directions, instructions and wishes of that person and if the Treasurer considers that it is in the national interest to make such declaration.

The question arises whether the Treasurer being vested with such wide powers to take decisions on the stakeholdings and control of a FSC in the national interest, on behalf of the Commonwealth, could hold the Commonwealth responsible to depositors of an FSC in the event of a failure of a FSC caused by the adverse financial circumstances of stakeholders and persons in control of the FSC. This question would arise whether the Treasurer approved a higher holding than 15 per cent or not. In the latter case given the authority to reduce a stake of a person the failure to act in time may carry the same exposure to liability as approving an increase in the stake.

It is relevant to note that proposed subsection 5(1) states that the Act binds the Crown in the right of the Commonwealth, of each of the States, of the Australian Capital Territory, of the Northern Territory and of Norfolk Island. Proposed subsection 5(2) states that this Act does not make the Crown liable to be prosecuted for an offence. As the Act binds the Crown and as the Act clearly specifies that the Crown is not liable to be prosecuted for an offence the question of civil liability for acts or omissions of the Crown in the right of the Commonwealth is not affected by the measures in the Bill. Section 56 of the Judiciary Act 1903 (Cth) authorises a person to bring a suit against the Commonwealth in a claim, whether in contract or tort. Section 64 of the same Act provides that in any suit to which the Commonwealth or a State is a party, the rights of parties shall as nearly as possible be the same as in a suit between subject and subject. Thus the provisions of the Judiciary Act 1903 (Cth) would operate to enable any aggrieved depositor to sue the Commonwealth, in the absence of measures to grant immunity to the Commonwealth from actions in tort in the Bill. In Commonwealth v Mewett (23) the High Court held in 1997 that the right to proceed against the Commonwealth in tort and contract stemmed from the Judiciary Act 1903 (Cth) which removed immunity from suit, but the liability itself derived from the common law which was preserved by the Constitution. It would therefore appear, that in view of this constitutional safeguard, the right of aggrieved depositors of a FSC to sue the Commonwealth in tort remains.

It is relevant to note that proposed section 70A to be inserted into the Banking Act 1959, by the Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998, in substitution of section 15 provides an indemnity to any person acting in good faith under the Banking Act 1959 in the following terms:

A person is not subject to any action, claim or demand by, or any liability to, any person in respect of anything done or omitted to be done in good faith and without negligence in connection with the exercise of powers or performance of functions under this Act or in compliance with obligations imposed by this Act(24).

Proposed section 58 of the Australian Prudential Regulation Authority Bill 1998 also provides an indemnity covering the APRA and its officers.

APRA, a Board member, an APRA staff member, or any agent of a Board member or APRA staff member, is not subject to any liability to any person in respect of anything done, or omitted to be done, in good faith in the exercise or performance of powers, functions or duties conferred or imposed on APRA, the Board or a Board member under this Act or any other law of the Commonwealth.

It will be seen that the indemnity under proposed section 58 covers anything done or omitted to be done under the Australian Prudential Regulation Authority Act 1998 or any other law of the Commonwealth. The Financial Sector (Shareholdings) Act 1998, when enacted will authorise the Treasurer to delegate any or all of his powers to delegate any or all of the Treasurer's powers to the Chief Executive Officer of APRA, or a member of the board of management of APRA or a APRA staff member. However, as the Treasurer does not have an indemnity under measures proposed in the Bill, officers of APRA acting under the delegated authority of the Treasurer will not be able to plead an indemnity which is not conferred on the Treasurer.

This Bills Digest considers the question of the continuing implied guarantee in the paragraph titled Concluding Comments.

Interaction with Foreign Acquisitions and Takeovers Act 1975

Proposed section 45 provides that the Foreign Acquisitions and Takeovers Act 1975 (FATA) and the measures in the Bill when enacted will operate independently of each other. It is relevant to note that FATA is an Act relating to the foreign acquisition of certain land interests and to the foreign control of certain business enterprises and mineral rights. Under Part 11 of FATA, which deals with control of takeovers and other transactions, the Treasurer has wide powers in the national interest to prevent the control of corporations by foreign interests. A foreign interest is briefly defined as:

• a natural person not ordinarily resident in Australia; and
• any corporation, business or trust in which there is a substantial foreign interest, ie, in which a single foreigner (and any associates) has 15 per cent or more of the ownership or in which several foreigners (and any associates) have 40 per cent or more in aggregate of the ownership.

Thus a single person and associates seeking to acquire more than 15% stake in a FSC will need to make application to the Treasurer under proposed section 13 of the Bill. Under paragraph 9(1)(a) of FATA, a person and any associates of that person in a position to control 15 per cent or more of the voting power or holding 15 per cent or more of the shares in a FSC will be taken to hold a substantial interest in the FSC. Under paragraph 9(2)(a) of FATA a person holding a substantial interest in a corporation is taken to hold a controlling interest in the corporation unless the Treasurer is satisfied that the person is not in a position to determine the policy of the corporation. Thus a foreigner proposing to acquire a 15 per cent stake in a FSC will come within the ambit of FATA but not necessarily be prevented from holding 15% under the proposed Bill. As proposed subsection 45(2) states that a decision under either Act has effect only for the purposes of the Act concerned, a person who has obtained approval under FATA to have a 15 per cent holding in a FSC may yet be declared to be in practical control under the measures in Division 4 of the Bill and required to reduce the stake in the FSC.

Under paragraph 9(1)(b) of FATA, two or more persons are taken to hold an aggregate substantial interest in a company if they, together with associate or associates of any of them, are in a position to control 40 per cent or more of the voting power or together hold interests of 40 per cent or more of the issued shares in a company. Under paragraph 9(2)(b) of FATA, 2 or more persons holding a substantial interest in a company shall be taken to hold a controlling interest in a company unless the Treasurer is satisfied that that those persons together with the associate or associates of any of them are not in a position to determine the policy of the company. The Bill does not have provisions corresponding to those in paragraphs 9(1)(b) and 9(2)(b). In consequence 2 or more foreign persons and their associates can have stakes in a FSC, each stake being not more than 15 per cent, and aggregating to less than 40 percent without reaching the thresholds in the Bill as well as in FATA. Thus 3 foreign persons each holding a 13% stake in a FSC will in aggregate hold a 39% stake in the FSC and still not reach the 15% threshold limit in the Bill for individual persons and the 40% threshold limit for aggregate holdings under FATA. Here again, the measures in Division 4 of the Bill are wide enough for the Treasurer to make declarations of practical in respect of each of the 3 foreign stakeholders in the FSC so as to prevent aggregate foreign ownership which does not exceed 40 per cent.

Concluding Comments

Is there a continuation of the implied guarantee to depositors?

The Regulation Impact Statement 2 (RIS 2) - Stability of the Financial System and Depositor Protection(25) - in the Explanatory Memorandum to the Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998 identifies two general problems with the current state of regulation for depositor protection. These relate to the ambiguity of the protection of depositors funds and the perception that their funds are guaranteed leading them to seek the highest returns without regard to attendant risks. This latter problem is referred to as the 'moral hazard' problem(26).

RIS 2 states that the regulatory objectives are to achieve effective levels of depositor protection consistent with the need to increase competition in the financial system, while minimising moral hazard and to achieve clarity in the minds of depositors regarding the extent to which their deposits are protected(27)^.

To achieve these objectives RIS 2 states the following five options were considered:

1. retention of the status quo;
2. deposit insurance;
3. retention of the present protection arrangements with some consolidation and clarification;
4. remove explicit depositor protection provisions entirely; and
5. industry self-regulation.

RIS 2 concludes that the third option builds on the current approach, addressing the flaws contained therein and is therefore the recommended option.(28)

The existing protection arrangements in the Banking Act 1959 are stated in RIS 2 as follows.

3.92 The current legislative basis for depositor protection is embodied in Division 2 of the Act. Section 12 of the Act requires the RBA to exercise its powers for the protection of depositors and section 16 gives priority to deposit liabilities above other liabilities. Section 14 provides triggers for management intervention by the RBA and allows the RBA to assume control of a bank. Although such action is in part discretionary (the RBA is required to act in the interests of depositors), once taken, the RBA under subsection 14(5) must remain in control and carry on the business of the bank at least until such time as 'the deposits with the bank have been repaid or the Reserve Bank is satisfied that suitable provision has been made for their repayment'.

Under the measures in the Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998, the only amendment to section 12 is to make that section apply to all authorised deposit taking institutions (ADIs) instead of to banks only, as at present. Sections 13,14, 15 and 16 are to be repealed and substituted by proposed sections 13 to 16A. The comparative position is as follows.

• If an ADI is unable to meet its obligations, proposed subsection 13A(3) provides the assets of the ADI in Australia are to be available to meet that ADI's deposit liabilities in Australia in priority to all other liabilities of the ADI. This corresponds to the provisions of subsection 16(1) which presently gives priority to deposit liabilities above other liabilities. Thus the contribution presently made by subsection 16(1) to the perception that depositors funds are in some way guaranteed by the Commonwealth will continue under proposed subsection 13A(3).
• The provisions of subsection 14(5) which require the Reserve Bank of Australia (RBA) to remain in control and carry on the business of a bank in difficulty, until such time that the deposit liabilities have been paid or the bank has been satisfied that suitable arrangements have been made for their repayment, have been replaced by the provisions of proposed subsection 13C(1). The proposed provisions are similar except there is no express requirement that the APRA, instead of the RBA, is to carry on the business of the ADI as the RBA is presently required to do under subsection 14(5). It is arguable that it is not necessary to require the APRA to carry on the business of a bank in difficulty, as the need for the APRA to step in will only arise when it is clear that the directors cannot carry on the business of the bank, given the enhanced preventative measures available to the APRA in the package of Bills.

It would be against the philosophy of prudential control adopted in the FSI Report, for the Commonwealth to be held liable to depositors for decisions taken in the national interest or to be held liable to depositors on the basis of an implied guarantee. However, the FSI did accept that it is difficult to completely shield the regulator not only legally from this implied guarantee but that it may not be in the best interests of ensuring continuing public confidence in the financial system to remove the public perception of an implied guarantee. To quote the FSI Report:

The Extent of Regulatory Assurances

The general philosophy underlying prudential regulation is outlined in Chapter 5. Prudential regulation is preventative in nature in that it is directed largely at preventing promissory breach through financial failure. Recognising that no system of preventative regulation is perfect in all circumstances, prudential regulation must also deal with the resolution of failure when it does occur. A philosophical issue constraining the design of a system of prudential regulation is appropriately limiting the extent of any regulatory assurance that attaches to regulated financial institutions and products regulated.

It is the Inquiry's view that any regulatory assurance should be tightly circumscribed. The reasons underlying this view are detailed in Chapter 5. Ultimately, it is the responsibility of the management and board of a financial institution to ensure that its businesses deliver on the promises made, and it is not appropriate for government to underwrite them. Prudential regulation adds an extra layer of oversight beyond regulation of disclosure and conduct, but this should not constitute a guarantee.

The Inquiry accepts that the extent of any regulatory assurance is necessarily imprecise. Regulatory action will not always follow the same predetermined path, since circumstances vary. In particular, it is a reality of the regulatory system that financial distress will be handled on a case-by-case basis where potential systemic risk is involved.

Further, systemic risk is related to perceptions. A prudential regulator is required to strike a difficult balance between increasing the likelihood that financial promises are kept and being perceived as the underwriter of those promises. Even if regulatory responsibility is clearly limited by law, the investing public may perceive the regulator as implicitly guaranteeing the creditworthiness of regulated institutions. Ironically, the regulator is perversely exposed in this respect to its own performance 3/4 the better its track record in preventing failure, the more likely the public is to regard the regulator as guaranteeing the underlying promises. Whatever the reality, perceptions can be a source of instability if they are found to be incorrect.

This issue is important in the Australian context. In some areas of prudential regulation, the extent of the regulatory assurance is unclear, even in law. Beyond this lack of clarity, the perceived extent of the regulatory assurance almost certainly exceeds the legal extent in almost all areas of prudential regulation.

An objective of the framework and approach to prudential regulation outlined below is to provide a structure that defines the limits of any regulatory assurance as clearly as possible and offers enough flexibility to adjust it, upwards or downwards, as the nature of the financial system evolves.(29)

It would appear that the measures in the package of Bills have not watered down the existing protection arrangements in the Banking Act 1959 as stated in paragraph 3.92 of RIS 2. These current arrangements have lead to the perception that depositor funds are in some way guaranteed giving rise to the moral hazard problem associated with such a perception. It is therefore likely that the perception of a guarantee of depositor funds will continue and so will the problem of moral hazard.

Endnotes

1. Australian Prudential Regulation Authority Bill 1998; Proposed Section 2
2. The package of Bills is as follows:
   Australian Prudential Regulation Authority Bill 1998
   Authorised Deposit -Taking Institutions Supervisory Levy Imposition Bill 1998
   Authorised Non-Operating Holding Companies Supervisory Levy Imposition Bill 1998
   Financial Institutions Supervisory Levies Collection Bill 1998
   Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998
   Financial Sector (Shareholdings) Bill 1998
   General Insurance Supervisory Levy Imposition Bill 1998
   Life Insurance Supervisory Levy Imposition Bill 1998
   Payment Systems (Regulation) Bill 1998
   Retirement Savings Account Providers Supervisory Levy Imposition Bill 1998
   Superannuation Supervisory Levy Imposition Bill 1998
3. Financial System Inquiry - Final Report (March 1997) - Chairman Mr Stan Wallis. The FSI and the FSI Report are popularly referred to as the Wallis Inquiry and Wallis Report.
4. Ibid., Recommendation 45, 339
5. Bills Digest on the Australian Prudential Regulation Authority Bill 1998.
6. FSI Report; Chapter 8 - Financial Safety; 297.
7. Ibid., paragraph 8.2, 300.
8. Ibid., paragraph 8.4.2, 338-339.
9. The Australian Financial Institutions Commission (AFIC) is a statutory authority set up under State and Territory laws in 1992. AFIC was set up by the Australian Financial Institutions Code 1992(Queensland) and given effect in other jurisdictions by an application of laws mechanism. The Australian Financial Institutions Code (FI Code) is contained in the Part 7 of the Australian Financial Institutions Code 1992.
10. Ibid., 337-338.
11. Ibid., 339
12. Proposed Schedule 8,Item 10
13. Mutual Pools and Staff Pty Ltd v Commonwealth (1994) 119 ALR 577
14. Health Insurance Commission v Peverill (1994) 119 ALR 675
15. Georgiadis v Australian and Overseas Telecommunications Corporation (1994) 119 ALR 629
16. Re DPP; Ex parte Lawler (1994) 119 ALR 655
17. Nintendo Co Ltd v Centronics Systems Pty Ltd (1994) 121 ALR 577
18. Legal Practice Briefing No. 13 of 28 July 1994, 4
19. Bank of NSW v Commonwealth (1948) 76 CLR 1 at p. 349
20. Minister for the Army v Dalziel (1944) 68 CLR 261 at 290
21. Newcrest Mining (WA) Ltd v Commonwealth ; (1997) 147 ALR 42; Kirby J at p. 150
22. Nintendo Co Ltd v Centronics Systems Pty Ltd (1994) 121 ALR 577
23. (1997) 146 ALR 299
24. Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998; proposed Schedule 2; Item 155.
25. Explanatory Memorandum to the Financial Sector Reform (Amendments and Transitional Provisions) Bill 1998; Regulation Impact Statement 2 - Stability of the Financial System and Depositor Protection -paragraphs 3.88 to 3.125
26. Ibid., paragraph 3.89
27. Ibid., paragraph 3.90
28. Ibid., paragraph 3.117
29. FSI Report; paragraph 8.2; 300-301

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Commonwealth of Australia 1998

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