Australia
Financial Sector Assessment Program: Detailed Assessment of Observance of Standards and Codes
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This assessment of the current state of Australia’s implementation of the Basel Core Principles for Effective Banking Supervision has been completed as part of a Financial Sector Assessment Program (FSAP) undertaken in December 2005 by the International Monetary Fund. The assessment team reviewed the legal framework for banking supervision. The team had the benefit of working with a comprehensive self-assessment completed by the Australian authorities, enjoyed excellent cooperation with its counterparts, and received all the information it required. The financial system is relatively large and diversified.

Abstract

This assessment of the current state of Australia’s implementation of the Basel Core Principles for Effective Banking Supervision has been completed as part of a Financial Sector Assessment Program (FSAP) undertaken in December 2005 by the International Monetary Fund. The assessment team reviewed the legal framework for banking supervision. The team had the benefit of working with a comprehensive self-assessment completed by the Australian authorities, enjoyed excellent cooperation with its counterparts, and received all the information it required. The financial system is relatively large and diversified.

I. Basel Core Principles

A. General

1. This assessment of the current state of Australia’s implementation of the Basel Core Principles for Effective Banking Supervision has been completed as part of a Financial Sector Assessment Program undertaken in December 2005 by the International Monetary Fund. An assessment of the effectiveness of banking supervision requires a review of the legal framework, both generally and as specifically related to the financial sector, and a detailed examination of the policies and practices of the institutions responsible for banking supervision.

2. Australia has adopted a functional approach to oversight of the financial system, with the roles and responsibilities of the various agencies broadly divided by regulatory objective. The Australian Prudential Regulation Authority (APRA) is the agency responsible for the prudential supervision of banks, insurers and superannuation funds. The Australian Securities and Investments Commission (ASIC) is the market conduct regulator and also administers the provisions of company law for both listed and unlisted companies. The Reserve Bank of Australia (RBA) has responsibility for payment system oversight and overall financial stability. The federal financial intelligence unit (FIU), the Australian Transaction Reports and Analysis Centre (AUSTRAC), has a dual role as both an FIU and anti-money laundering and countering the financing of terrorism (AML/CFT) regulator. As the AML/CFT regulator, AUSTRAC is responsible for ensuring compliance with current AML/CFT legislation. With respect to banking and other financial services issues, the Treasury is responsible for the preparation of laws and regulation and provides the Treasurer with policy advice. Legislation confers on the Treasurer certain responsibilities and the Treasurer might also play a role in financial sector supervision through issuing directions to APRA and ASIC. With respect to AML/CFT, the Attorney-General’s Department is responsible for the preparation of laws and regulation and provides the Minister for Justice and Customs with policy advice.

B. Information and Methodology Used for Assessment

3. The assessment team1 reviewed the legal framework for banking supervision, held extensive discussions with the staff of the APRA, ASIC, the RBA, ASIC, the Treasury and participants in the banking and financial markets, and examined the current practice of APRA’s on-site and off-site supervision. The assessment team had the benefit of working with a comprehensive self-assessment completed by the Australian authorities, enjoyed excellent cooperation with its counterparts, and received all the information it required. The team extends its thanks to the staff of the various agencies and the Treasury and in particular to the staff of APRA for their participation in the process and comprehensive self-assessment.

4. Reaching conclusions required judgments by the assessment team. Banking systems differ from one country to another, as do their domestic circumstances. Furthermore, banking activities are changing rapidly around the world, and theories, policies, and best practices for supervision are swiftly evolving. Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the Australian authorities with a reliable measure of the quality of its banking supervision in relation to the Core Principles, which are internationally acknowledged as minimum standards.

5. The assessment of compliance with each principle is made on a qualitative basis. A four-part assessment system is used: compliant; largely compliant; materially non-compliant; and non-compliant. To achieve a “compliant” assessment with a principle, all essential criteria generally must be met without any significant deficiencies. A “largely compliant” assessment is given if only minor shortcomings are observed, and these are not seen as sufficient to raise serious doubts about the authority’s ability to achieve the objective of that principle. A “materially non-compliant” assessment is given when the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance, but substantive progress had been made. A “non-compliant” assessment is given when no substantive progress toward compliance has been achieved.

C. Preconditions

6. The preconditions for effective banking supervision are well established in Australia. Over the past two decades, Australia has implemented wide-ranging structural reforms and strengthened the frameworks for monetary and fiscal policies, which have yielded rapidly rising incomes through strong job creation and high productivity growth. The economic expansion that began in 1992 is now in its fourteenth year. The unemployment rate has fallen by 6 percentage points since 1992, supported by more flexible labor markets and welfare reforms. Inflation has remained low and net public debt has been all but eliminated, all in the context of a stable and resilient economy.

7. The financial system is relatively large and diversified. Financial system assets amount to over 300 percent of GDP. Authorized deposit-taking institutions (ADIs, consisting of banks, credit unions, and building societies) account for about half of total financial system assets.2 A further 23 percent of assets are held by life insurers and superannuation funds. Stock market capitalization is also relatively large, at over 100 percent of GDP.

8. The banking system was made up of 238 ADIs, including 14 Australian-owned banks, 11 foreign subsidiary banks, 28 branches of foreign banks, 14 building societies, 158 credit unions, 3 specialist credit card institutions, and 3 ADIs that provide services to member building societies and credit unions. Of the banks, the largest five held some 74 percent of assets, with the bulk of the remainder being held by other domestic banks, locally incorporated foreign banks, and foreign bank branches. The credit unions and building societies play a modest role, with their total assets comprising less than 2 percent of total ADI assets.

Monetary policy framework

9. The power to determine monetary policy is conferred on the Board of the RBA by the Reserve Bank Act 1959, which requires the Board to conduct monetary policy in a way that, in the RBA Board’s opinion, will best contribute to the objectives of the stability of the currency of Australia, the maintenance of full employment, and the economic prosperity and welfare of the people.

10. The RBA Board conducts monetary policy independently of the Government. This is made explicit in the Statement on the Conduct of Monetary Policy agreed between the Treasurer and the Reserve Bank Governor in 1996 and reaffirmed and updated in 2003. The Statement includes a commitment by the RBA to hold consumer price inflation to between 2 and 3 percent, on average, over the course of the cycle. Under the Statement, the Government notes the role that disciplined fiscal policy must play in achieving the inflation objective. Monetary policy is conducted through the cash rate. Open market operations by the RBA in the money market keep the cash rate at or near an operating target decided by the RBA Board.

Currency regime

11. The Australian dollar was floated in 1983 and has become a key economic shock absorber. By moving broadly in accordance with the fluctuations in external demand and commodity prices, the exchange rate has tempered the impact of these fluctuations on Australian economic activity.

Disclosure arrangements

12. Listed companies are subject to a modern continuous disclosure regime, and ADIs (the majority by number are not listed) are subject to specific disclosure requirements which include publication of their annual reports. APRA prescribes key elements to be disclosed, including the entities’ governance and risk-management arrangements, as well as audited financial statements. APRA also publishes financial statement information on the industry.

The legal system

13. The Commonwealth of Australia has a federal system of government which consists of the Commonwealth Government, six State Governments and two Territory Governments. The Australian Constitution (1901) establishes the Federal government and sets out the basis for relations between the Commonwealth and the States. It also provides the system of separation of powers, by providing for the Parliament, the Executive government, and the Judiciary. APRA operates in accordance with Commonwealth law, and the winding up of banks is carried out under Commonwealth law.

14. The Constitution gives the legislative power to Parliament. Proposed legislation must be passed by both Houses of Parliament to become law. The Houses are elected by the Australian people and have equal powers, with minor exceptions. The nominal head of state is the Queen’s representative in Australia, the Governor-General, who acts on the advice of the Executive government.

15. The Executive government administers the law and carries out the business of government through such bodies as government departments, statutory authorities and the defense forces. Only Parliament can pass Acts to create statute law, but these Acts often confer on the Executive the power to make regulations, rules and by-laws in relation to matters relevant to the particular Acts.

16. Australia is subject to the rule of law. The essence of the rule is that all authority is subject to, and constrained by, the law. The rule of law also means that each citizen is equal before the law; that laws must be predictable and known to all; and that laws must be fair and apply equally to the government as well as to those it governs. This includes the openness of courts, judicial independence from government and the presumption of innocence. English common law and equitable principles are the foundation of Australian laws.

17. The Australian court system has two arms: Federal and State/Territory. The constitution provides that the judicial powers of the Commonwealth are vested in the High Court of Australia. High Court judges are appointed by the Governor-General in Council, after extensive consultation and upon the basis of merit. Australian State and Territory courts have original jurisdiction under all matters brought under State or Territory laws and in other matters where the jurisdiction has been conferred on the courts by the Commonwealth parliament. Only a court may exercise the judicial power and examine the question of whether a person has contravened a law of Parliament.

18. The provisions of the Corporations Act that deal with corporate insolvency are primarily concerned with efficient procedures for the winding up of companies, the orderly realization of available assets of those companies and the equitable distribution of the proceeds to creditors, employees and shareholders. There are also provisions governing the appointment of receivers or other persons who are entitled to assume control over particular assets of the company; the reconstruction of companies; arrangements and compromises with creditors; and the voluntary winding up of solvent companies.

19. There are three types of external administration of insolvent companies: liquidation, receivership and voluntary administration. A company comes under external administration when its directors must relinquish direction of its affairs to a receiver, administrator, provisional liquidator or liquidator. Directors have to consider the options for external administration because they are under a legal obligation to cause an insolvent company to cease trading. If they fail to do so they may be held personally liable for the company’s debts.

Accounting and auditing

20. From January 2005, Australia adopted International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB). Some Australian-specific accounting standards have been retained to deal with particular issues, such as disclosure of director and executive remuneration, and concise financial reports.

21. A listed company is required to lodge with ASIC annual and half-yearly financial reports. The financial statements must be prepared in accordance with IFRS and must provide a true and fair picture of the entity’s financial position and performance. The annual accounts must be audited, with the half-yearly reports subject to either review or audit. Large non-listed companies are required to lodge annual statements with ASIC. ASIC has granted some relief to compliance with accounting standards to non-listed companies which are defined as “non-reporting companies.” Exemptions from reporting requirements are also provided for small non-listed companies.

22. The accounting profession in Australia is well established and recognized as being of a high international caliber. In order to audit a listed company’s financial report, the auditor must be registered under the Corporations Act. In order to be registered, ASIC must form an opinion that the applicant has the necessary qualifications, satisfies the auditing competency standard and is capable of performing the duties of an auditor. Oversight of auditors is provided by ASIC and the professional accounting bodies. Disputes over the behavior of auditors are decided by the Companies Auditors and Liquidators Disciplinary board. There are currently 6110 registered auditors. Auditing standards in Australia are established by the Auditing and Assurance Standards board (AUASB), and are based on International Standards on Auditing (ISAs). The Financial Reporting Council oversees the AUASB and the AASB.

Prudential regulation framework

23. Prudential regulation of the Australian financial system (authorized deposit-taking institutions, insurance companies, and superannuation funds) is undertaken by APRA, which aims to ensure that, under all reasonable circumstances, financial promises made by regulated entities are met within stable, efficient and competitive financial markets. Australia’s prudential framework is risk-based, and based on a consultative dialogue between supervisors and regulated entities. The risk-based approach recognizes that management and boards of supervised institutions are primarily responsible for financial soundness of their respective institution. Where difficulties arise, intervention by the regulator will be proportionate to the seriousness of the problem and the level of risk to policyholders and industry.

Mechanisms for dealing with problem banks

24. APRA has a broad range of supervisory powers which escalate from preventative, through to corrective, to failure management:

  • Preventative powers include the authorization framework, the tests of fitness and propriety, and the implementation of prudential standards.

  • Correction powers include court-enforceable undertakings, e.g. agreements between APRA and market participants, and issuing of directions to supervised entities. In serious and/or immediate cases APRA has the power to seek court injunctions.

  • Failure management powers include the ability to apply for the transfer of business of an entity that is in financial distress to a healthy institution; to initiate external administration; and to initiate wind-up.

APRA’s powers and their use in practice are addressed in more detail in the principle-by-principle assessment.

25. The Reserve Bank of Australia (RBA) is able to provide emergency liquidity (as a “lender-of-last-resort”) to distressed ADIs. The stated policy of the RBA is that it would consider lending to an ADI only if it was of the view that the failure of the institution represented a systemic threat. Furthermore, the RBA would not be willing to extend liquidity support to an insolvent institution.

26. The Government has not yet decided whether to introduce some form of explicit depositor guarantees in Australia. At present, there is depositor preference in authorized deposit taking institutions (ADIs). Hence, in liquidation, depositor claims are given priority over other claims on the estate. In the HIH Insurance failure, the Government responded on a discretionary basis to compensate policy holders. In two cases of near-failures of banks owned by State governments, their respective owners ensured that all creditors’ claims were met. The long history of depositors not suffering losses in bank failures, in part due to government intervention, creates the impression that there is an implicit government guarantee of deposits.

D. Detailed Assessment

27. This assessment has been completed against the Core Principles essential criteria, which is the FSAP standard. In the description and comments below references are made to the additional criteria. Australia has a high level of compliance with both the essential and additional criteria, reflecting a supervisory framework and practice which captures almost all elements of current international best practices. In many areas, such as capital adequacy and the overall approach to risk-based supervision, Australia is at the leading edge of current international practice.

Table 1.

Principle by Principle Assessment of Basel Core Principles

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Table 2.

Summary of Compliance with the Basel Core Principles

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C: Compliant.

LC: Largely compliant.

MNC: Materially non-compliant.

NC: Non-compliant.

E. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

28. Australia has already initiated plans to address the most serious shortcomings in the implementation of the Basel Core Principles for Effective Banking Supervision, which relate to Core Principle 15. It is intended that AUSTRAC will develop the necessary skills and expertise to undertake the needed on-site verification of bank’s implementation of measures to prevent abuse by criminal elements. Coordination and information sharing between AUSTRAC and APRA will be vital in this regard because many of the specific requirements of CP 15 extend beyond the narrow confines of AML/CFT issues. If AUSTRAC is unable to share information with the prudential supervisor, it will not be possible to effectively implement measures to ensure APRA is apprised on a comprehensive and timely basis of any issues that might affect soundness, for instance though reputational risk. It will also be important the APRA receives the full benefits of insights into the broader issues of internal control and compliance than can come from the detailed on-site review of the specific aspects of internal controls that will be undertaken by AUSTRAC.

29. While the provisions to ensure operational independence of APRA fall short of those of the RBA, they currently provide a generally adequate framework to meet the requirements of the Core Principles. The power of the Treasurer to give directions to APRA has not been used; however, it would provide greater certainty regarding the independence of the prudential supervisor if this provision were removed. It would appear possible that making APRA subject to the Financial Management and Accountability Act could lead to a diminution of operational independence, and it would be preferable to maintain the greater independence arising from the current status under the Commonwealth Authorities and Companies Act.

30. Consideration should be given to revising the criteria for Section 11 exemptions to ensure that only institutions which fund themselves on a truly wholesale basis may be exempted from APRA regulation and supervision. An amended and clearer demarcation line between authorized and exempted institutions, better reflecting today’s financial market structures and instruments, would address the current concern that there is little difference in practice between unlicensed and unsupervised finance companies and foreign bank subsidiaries that fund themselves using instruments issued by prospectus which may be easily mistaken, especially by retail investors, as deposits. The revised criteria could be used to ensure that all subsidiaries of foreign banks undertaking bank-like activity in Australia are subject to APRA oversight.

31. APRA’s approach to supervision is commendable, with the PAIRS/SOARS approach reflecting current best practices in risk-focused supervision. The overall approach is still quite new, and subject to ongoing refinement. One area for improvement would be the introduction of greater standardization in off-site analysis. While it is important to avoid a check-list mentality, some of the variation in quality currently observed could be addressed by providing staff with greater guidance to shape their exercise of supervisory judgment.

32. Specific recommendations for individual principles assessed as less than fully compliant are provided below. Additional observations and suggestions are provided in the comments of a number of principles where it is possible, in the view of the assessors, to enhance the already high standard of supervision.

Table 3.

Recommended Action Plan to Improve Compliance of the Basel Core Principles

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Authorities’ response

The Australian Government considers that this has been a high quality assessment and is valuable in assisting it to consider its framework for regulating banks. It shows Australia’s high level of compliance with the core principles.

The authorities are aware of the issues raised in relation to the framework for protection of depositors in the ‘preconditions’ section of the assessment and they have been noted in the Reserve Bank of Australia’s March 2006 Financial Stability Review. The work that is currently being undertaken by the Council of Financial Regulators on the potential introduction of a Financial Claims Compensation Scheme recognizes such community attitudes to support in the event of a failure.

In relation to Principle 1(2) the Australia Government recognizes that, to achieve high quality outcomes in prudential regulation, it is important to have a regulator with operational independence from government. However, it is also an important element of Australia’s system of ministerial accountability that governance and accountability arrangements operate in such a way that regulators follow the policy intention of the parliament when implementing legislation.

The Government considers that the power of the Treasurer to issue directions to APRA on policies and priorities (but not particular cases) strikes an appropriate balance in this regard. The conditions attached to this power, such as discussing the proposed direction with the APRA Chair and tabling the direction in parliament, provide transparency and accountability in its use, such that a direction would only be considered as a final option. To date the Treasurer has not given APRA any directions under this power.

As part of a government wide review of statutory authorities, the Treasurer has agreed to move APRA’s financial framework to the Financial Management and Accountability Act 1997 (FMA Act) from the current Commonwealth Authorities and Companies Act 1997 (CAC Act). Prudential regulation is a core function of government, and the FMA Act is the financial framework that most appropriately applies to agencies delivering core functions. The CAC Act is most applicable to government entities that undertake commercial operations.

The Government does not consider that this change will materially affect APRA’s operational independence or funding. It is APRA’s enabling legislation (the Australian Prudential Regulation Authority Act 1998) that establishes the required level of operational independence necessary to exercise statutory powers objectively. Further, the Government has exempted APRA from a small number of conditions under the FMA Act that may affect its ability to fulfill its duties efficiently and effectively. As a result, the change to the FMA Act will not affect how APRA is funded or reduce its autonomy in deciding how it spends its funding and organizes itself (including its ability to set the employment terms and conditions of its staff) to meets its statutory obligations.

More generally, the Australian Government notes that its overall approach to fiscal policy over the last decade, in which all public sector spending is subject to robust discipline, has served Australia well, ensuring adequate funding for government services and agencies while producing a degree of sustained fiscal responsibility unmatched by many other OECD economies.

On Principle 15, as the IMF has noted, the Government is committed to updating Australia’s anti-money laundering and counter-terrorist financing (AML/CTF) regime to reflect developments in financial crime and revised international standards from the Financial Action Task Force on Money Laundering (FATF).

In keeping with its commitment the Government is closely consulting with industry on a range of reforms. Legislation is expected to be introduced during 2006. The reforms when implemented will bring Australia into compliance with the FATF recommendations and will ensure that Australia’s financial sector, in meeting its obligations, remains robust and internationally competitive.

Processes are currently in place to amend the existing Financial Transaction Reports Act 1988 to allow AUSTRAC to share FTR information with APRA. This will also involve the establishment of a memorandum of understanding between the two authorities. Under the proposed AML/CFT legislation APRA will be included as a partner agency with which AUSTRAC can share FTR information. These arrangements will ensure that APRA is provided with information essential to assessing reputational and liquidity risks within APRA regulated institutions. In addition, APRA and AUSTRAC will continue to improve broader cooperation and coordination arrangements.

In relation to the comments on Principle 22, the Government is currently reviewing the application of merits review to APRA decisions following a recommendation of the HIH Royal Commission and, more recently, a recommendation of the Taskforce on Reducing the Regulatory Burden on Business. The review will take into consideration the need for APRA to be able to take timely decisions where they are necessary to protect the interests of depositors and/or other policyholders. The review will also seek to balance the objective of timeliness with the need to ensure that persons affected by decisions are treated fairly.

Merits review is a key element of Australia’s system of administrative review and, where appropriate, offers the potential for a cost effective and relatively timely review of an administrative decision. In the absence of the availability of merits review, persons affected by decisions would have recourse to judicial review by the courts.

II. Insurance Core Principles and methodology

33. This assessment examines Australia’s observance with the ICP issued by the International Association of Insurance Supervisors (IAIS) in October 2003. The assessment was conducted by Su Hoong Chang from November 30 to December 14, 2005 as part of the IMF Financial Sector Assessment Program (FSAP). The assessment is based on the assessment methodology established by the IAIS.

34. The level of observance for each ICP reflects the assessments of the essential criteria only. Assessment of advanced criteria is not included in assessing observance with ICP. An ICP will be considered observed whenever all the essential criteria are considered to be observed or when all the essential criteria are observed except for a number that are considered not applicable. For an ICP to be considered largely observed, it is necessary that only minor shortcomings exist which do not raise any concerns about the authority’s ability to achieve full observance. An ICP will be considered partly observed whenever, despite progress, the shortcomings are sufficient to raise doubts about the authority’s ability to achieve observance. A Principle will be considered not observed whenever no substantive progress toward observance has been achieved.

35. Separate assessments are made for the life and general industries based on their respective legislation and regulatory regimes. Given the distinct legal and regulatory regimes for the two industries, different observance levels are recorded, where applicable. The assessments are based on a) a comprehensive self-assessment prepared by the authorities; b) a review of applicable laws, regulator/supervisory guidance and procedures; c) analysis regulatory and market data; d) interviews with staff of the authorities, industry participants, industry and professional associations; and e) documentation provided by various interviewees.

36. The assessments are based solely on the laws, regulations and other supervisory requirements and practices that are in place at the time of assessment. The authorities are in the process of reforming certain aspects of the supervisory framework during the FSAP mission. The progress of there initiatives, which have yet to be fully implemented, are noted in the report by way of additional comments.

37. The mission is grateful to the Treasury, APRA, ASIC and ATO for their full cooperation and assistance with the logistical arrangements and co-coordination of various meetings with industry bodies and companies. They have provided comprehensive responses to an extensive questionnaire as well as a thorough self assessment against the ICPs. Discussions with and briefings by the authorities during a series of technical meetings also facilitated a meaningful assessment of Australia’s adoption of international best practices.

Table 4.

Principle by Principle Assessment of IAIS Core Principles

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Table 5.

Summary Observance of the IAIS Core Principles

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O - Observed

LO - Largely Observed

PO - Partly Observed

NO - Not Observed

G — General Insurance

L — Life Insurance

A. Recommended Action Plan and Authorities Response to the Assessment

Table 6.

Recommended Action Plan to Improve Observance of the Insurance Core Principles

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Authorities’ response

The authorities appreciate the IMF’s considered views and recommendations contained in the assessment, which will be taken into account in developing the policy agenda for further insurance reforms.

Supervisory Authority

In addition to APRA having the power to make Prudential Standards, APRA and ASIC provide valuable input into the policy and legislative process. However, it has to be recognized that the development and passage of legislation is subject to constraints imposed by the Government’s overall policy program and the priorities accorded particular policy agendas. Accordingly, it is not possible to give any guarantee about the timing of adopting proposals put forward by APRA and ASIC.

It is recognized that to achieve high quality outcomes in prudential regulation it is important to have regulators with operational independence from government. However, it is also important that governance and accountability arrangements operate in such a way that regulators follow the policy intention of the parliament when implementing legislation. The Government considers that the power of the Treasurer to issue directions to APRA on policies and priorities (but not particular cases) strikes an appropriate balance between accountability and transparency. The conditions attached to this power, such as discussing the proposed direction with the APRA Chair and tabling the direction in parliament, provide a substantial check on its use, such that a direction would only be considered as a last resort. To date the Treasurer has not given APRA any directions under this power.

As part of a government wide review of statutory authorities, the Treasurer has agreed to move APRA’s financial framework to the Financial Management and Accountability Act (FMA Act) from the current Commonwealth Authorities and Companies Act (CAC Act). The Treasurer considers prudential regulation to be a core function of government, and the FMA Act is the financial framework that most appropriately applies to agencies delivering those functions. The CAC Act is most applicable to government entities that undertake commercial operations.

The Government does not consider that this change will materially affect APRA’s operational independence or funding. It is APRA’s enabling legislation (the Australian Prudential Regulation Authority Act 1998) that establishes the required level of operational independence necessary to exercise statutory powers objectively. Further, the Government has used its powers to exempt APRA from a small number of conditions under the FMA Act that may affect its ability to fulfill its duties efficiently and effectively. As a result, the change to the FMA Act will not affect how APRA is funded or reduce its autonomy in deciding how it spends its funding and organizes itself (including its ability to set terms and conditions of its staff) to meets its statutory obligations.

In general, the Australian Government notes that its overall approach to fiscal policy over the last decade, in which all public sector spending is subject to robust discipline, has served Australia well, ensuring adequate funding for government services and agencies while producing a degree of sustained fiscal responsibility unmatched by many other OECD economies.

The Treasury does not have any involvement in the operational decisions of APRA or ASIC. Currently, the Treasurer’s agreement must be sought before certain administrative actions or decisions are taken under the Insurance Act and the Life Insurance Act. The Treasurer’s agreement for APRA decisions was based on the need to ensure that APRA was able to act in a timely manger to protect the interests of depositors and/or policyholders, while ensuring that there was review of those administrative decisions to protect persons affected. The Government agreed to remove the Treasurer’s involvement in operational decisions, other than in cases where broader policy issues were not involved, as part of its response to the HIH Royal Commission.

The Financial Sector (Shareholdings) Act (FSSA) which imposes controls on the ownership of financial entities is not administered by APRA as it is not an Act related to prudential supervision; however, prudential aspects are taken into account when considering applications for changes in ownership. In making decisions under the Act, the Treasurer takes account of APRA’s advice. In certain instances, determined by monetary thresholds, the Treasurer has delegated his powers under the FSSA Act to senior APRA staff.

Licensing

We disagree with the rating of ‘partly observed’ for general insurance.

Australia’s licensing regime was substantially revised in 2001 and in 2002 all existing insurers were subjected to a rigorous re-licensing process. As a consequence, we consider that Australia has demonstrated that it has in place a robust, well-tested licensing regime to ensure that only well-resourced and prudentially sound insurance companies are licensed. While it is acknowledged that DMFs and DOFIs are not prudentially supervised by APRA at this time, they are required to comply with AFSL license requirements. In view of the relatively small market share held by DMFs and DOFIs, we consider that the rating given places undue emphasis on the deficiencies identified and does not have sufficient regard to Australia’s otherwise robust licensing framework. Neither does it recognize the Government’s agreement to implement the key recommendations of the Potts Review.

Internal control

We consider that the ‘largely observed’ rating for general insurance with respect to principle 10 should be revised to ‘observed’ as a result of the release of the risk and financial management prudential standard and the corresponding non-binding prudential practice guide. This prudential standard will be effective from 1 October 2006 and address the concerns raised in the assessment.

Enforcement or sanctions

The Government is currently reviewing the application of merits review to APRA decisions following a recommendation of the HIH Royal Commission, and more recently, a recommendation of the Taskforce on Reducing the Regulatory Burden on Business. The review will take into consideration the need for APRA to be able to take timely decisions where they are necessary to protect the interests of depositors and/or other policyholders. The review will also seek to balance the objective of timeliness with the need to ensure that persons affected by decisions are treated fairly.

Merits review is a key element of Australia’s system of administrative review and, where appropriate, offers the potential for a cost effective and relatively timely review of an administrative decision. In the absence of the availability of merits review, persons affected by decisions would have recourse to judicial review by the courts.

Anti-money laundering, combating the financing of terrorism

As the IMF has noted, the Government is committed to updating Australia’s anti-money laundering and counter-terrorist financing (AML/CTF) regime to reflect developments in financial crime and revised international standards from the Financial Action Task Force on Money Laundering (FATF).

In keeping with its commitment the Australian Government is closely consulting with industry on a range of reforms. Legislation is expected to be introduced during 2006. The reforms when implemented will bring Australia into compliance with the FATF recommendations and will ensure that Australia’s financial sector, in meeting its obligations, remains robust and internationally competitive.

Processes are currently in place to amend the existing Financial Transaction Reports Act 1988 to allow AUSTRAC to share FTR information with APRA. This will also involve the establishment of a memorandum of understanding between the two authorities. Under the proposed AML/CTF legislation APRA will be included as a partner agency with which AUSTRAC can share FTR information. These arrangements will ensure that APRA is provided with information essential to assessing risks within APRA regulated institutions. In addition, APRA and AUSTRAC will continue to improve broader cooperation and coordination arrangements.

III. IOSCO Objectives and Principles of Securities Regulation

A. General

38. This assessment of the current state of Australia’s implementation of the IOSCO Objectives and Principles of Securities Regulation has been completed as part of a Financial Sector Assessment Program undertaken in December 2005 by the International Monetary Fund. An assessment of the effectiveness of securities regulation requires a review of the legal framework, both generally and as specifically related to the financial sector, and a detailed examination of the policies and practices of the institutions responsible for securities regulation.

39. Australia has adopted a functional approach to oversight of the financial system, with the roles and responsibilities of the various agencies broadly divided by regulatory objective. The Australian Securities and Investment Commission (ASIC) is the market conduct regulator and also administers the provisions of company law for both listed and unlisted companies. The Australian Prudential Regulation Authority (APRA) is the agency responsible for the prudential supervision of banks, insurers and superannuation (pension) funds. The Reserve Bank of Australia (RBA) has responsibility for payment system oversight and overall financial stability. The federal financial intelligence unit (FIU), the Australian Transactions Reports and Analysis Centre (AUSTRAC), is also responsible for anti-money laundering and countering the financing of terrorism (AML/CFT) regulation and on-site verification in financial institutions. Investigations are carried out by law enforcement agencies. As the AML/CFT regulator, AUSTRAC is responsible for ensuring compliance with current AML/CFT regulation. With respect to banking and other financial services issues, the Treasury is responsible for the preparation of laws and regulation, and provides the Treasurer with policy advice. Legislation confers on the Treasurer certain responsibilities and the Treasurer might play a direct role in financial sector supervision through legal powers to issue directions to APRA and ASIC. With respect to AML/CFT, the Attorney-General’s department is responsible for the preparation of laws and regulations and provides the Minister for Justice and Customs with policy advice.

40. In the last four years regulators and the financial services industry have been implementing a substantial body of change mandated by the Financial Services Reform Act 2001. The introduction of compulsory superannuation (pension) contributions in 1992 has raised public interest in, and expectations of, securities markets, financial intermediaries and their regulators.

B. Information and Methodology Used for Assessment

41. The assessor3 reviewed the legal framework for securities regulation, held extensive discussions with the staff of ASIC, APRA the Treasury and participants in the banking and financial markets, and examined the current practice of ASIC’s supervision of financial services providers. The assessor had the benefit of working with a comprehensive self-assessment completed by the Australian authorities, enjoyed excellent cooperation with his counterparts, and received all the information he required. The assessor extends his thanks to the staff of the various agencies and the Treasury and in particular to the staff of ASIC for their participation in the process and comprehensive self-assessment.

42. Reaching conclusions required judgments by the assessor. Securities markets differ from one country to another, as do their domestic circumstances. Furthermore, the structure of securities markets and the range of products available are changing rapidly around the world, and theories, policies, and best practices for regulation are swiftly evolving. Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the Australian authorities with a reliable measure of the quality of its securities regulation in relation to the IOSCO Principles.

43. The assessment of compliance with each principle is made on a qualitative basis. A Principle will be considered to be Implemented whenever all assessment criteria are generally met without any significant deficiencies. Broadly implemented applies whenever a jurisdiction’s inability to provide affirmative responses to applicable Key Questions for a particular Principle are limited to the questions excepted under the Principle’s broadly implemented benchmark and, in the judgment of the assessor, such exceptions do not substantially affect the overall adequacy of the regulation that the Principle is intended to address. Partly implemented applies whenever the assessment criteria specified under the partly implemented benchmark for that Principle are generally met without any significant deficiencies. A Principle will be considered to be Not implemented whenever major shortcomings are found in adhering to the assessment criteria as specified in the not implemented benchmark. Not applicable will apply whenever it does not apply given the nature of the securities market in the given jurisdiction and relevant structural, legal and institutional considerations.

C. Capital Markets

44. Key facts: Australia ranks globally as the seventh biggest foreign exchange market; the $US/$AUS is the fourth most-traded currency pair; the Australian dollar is the sixth most-trade currency; the stock market is rated eighth largest in the world; and Australia has the tenth largest market for international debt securities.

45. The Australian Stock Exchange Limited (ASX) operates the largest equities market and clearing and settlement facilities in Australia, accounting for over 99 percent of equities trading. Average daily turnover was some $A 3.2 billion during 2004-05, of which some 78 percent came from institutional investors. Between 1990 and 2005, the total domestic capitalization of the 1,774 companies listed on the ASX capitalization increased by more than 500 percent to $A 975 billion at end-June 2005. The ASX in 2004 was the fourth most active globally for capital raising-US$7.8 billion via 166 IPOs.

46. Forty-two percent of the market by value is owned by foreign institutions. It is the second largest exchange, behind Tokyo, in the Asia-Pacific region,

47. There are two main derivatives markets in Australia, the ASX and the Sydney Future Exchange (SFE). The ASX derivatives market is small compared to its equity market business and traded some 22.6 million contracts during 2004-05. The SFE, the second largest derivatives market in the Asia-Pacific region, is much larger than the ASX, with approximately 54.6 million contracts traded during 2004. Besides these exchanges, the OTC securities and derivatives markets offer liquidity across a wide range of financial products. In 2004/5, total turnover for OTC transactions exceeded $A 58 trillion compared to total on-exchange turnover of $A 24 trillion. Australia’s share of global debt markets is around one percent, with the commonwealth government, the state/territory governments, and corporations as the three groups of issuers. The value of the commonwealth government bonds on issue has been declining since 1997, and the corporate sector is now the largest issuer of bonds in Australia, although in global terms the domestic bond market is small. As at end-March 2005, the total value of bonds on issue by domestic borrowers in Australia was approximately $A 260 billion.

D. General Preconditions for Effective Securities Regulation

48. The preconditions for effective securities regulation are well established in Australia. Over the past two decades, Australia has implemented wide-ranging structural reforms and strengthened the frameworks for monetary and fiscal policies, which have yielded rapidly rising incomes through strong job creation and high productivity growth. The economic expansion that began in 1992 is now in its fourteenth year. The unemployment rate has fallen by 6 percentage points since 1992, supported by more flexible labor markets and welfare reforms. Inflation has remained low and net public debt has been all but eliminated, all in the context of a stable and resilient economy.

49. The financial system is relatively large and diversified. Financial system assets amount to over 300 percent of GDP. Authorized deposit-taking institutions (ADIs, consisting of banks, credit unions, and building societies) account for about half of total financial system assets. A further 23 percent of assets is held by life insurers and superannuation funds. Stock market capitalization is also relatively large, at over 100 percent of GDP.

Monetary policy framework

50. The power to determine monetary policy is conferred to the Board of the RBA by the Reserve Bank Act 1959, which requires the board to conduct monetary policy in a way that, in the RBA Board’s opinion, will best contribute to the objectives of the stability of the currency of Australia, the maintenance of full employment, and the economic prosperity and welfare of the people.

51. The RBA Board conducts monetary policy independently of the Government. This is made explicit in the Statement on the Conduct of Monetary Policy agreed between the Treasurer and the Reserve Bank Governor in 1996 and reaffirmed and updated in 2003. The Statement includes a commitment by the RBA to hold consumer price inflation to between 2 and 3 percent, on average, over the course of the cycle. Under the Statement, the Government notes the role that disciplined fiscal policy must play in achieving the inflation objective. Monetary policy is conducted through the cash rate. Open market operations by the RBA in the money market keep the cash rate at or near an operating target decided by the RBA Board.

Currency regime

52. The Australian dollar was floated in 1983 and has become a key economic shock absorber. By moving broadly in accordance with the fluctuations in external demand and commodity prices, the exchange rate has tempered the impact of these fluctuations on Australian economic activity.

Shareholder rights

53. Listed companies are required to publish annual and half yearly audited accounts, hold annual general meetings subject to proper advice notice and are subject to a modern continuous disclosure regime. Shareholder rights are respected (5% of shareholders can call for an extraordinary general meeting) and the interests of minority shareholders are properly protected. There is a lively market in corporate control subject to oversight and intervention when necessary by ASIC and the government funded Takeovers Panel.

The legal system

54. The Commonwealth of Australia has a federal system of government which consists of the Commonwealth Government, six State Governments and two Territory Governments. The Australian Constitution (1901) establishes the Federal government and sets out the basis for relations between the Commonwealth and the States. It also provides the system of separation of powers, by providing for the Parliament, the Executive government, and the Judiciary.

55. The Constitution gives the legislative power to Parliament. Proposed legislation must be passed by both Houses of Parliament to become law. The Houses are elected by the Australian people and have equal powers, with minor exceptions. The nominal head of state is the Queen’s representative in Australia, the Governor-General, who acts on the advice of the Executive government.

56. The Executive government administers the law and carries out the business of government through such bodies as government departments, statutory authorities and the defense forces. Only Parliament can pass Acts to create statute law, but these Acts often confer on the Executive the power to make regulations, rules and by-laws in relation to matters relevant to the particular Acts.

57. Australia is subject to the rule of law. The essence of the rule is that all authority is subject to, and constrained by, the law. The rule of law also means that each citizen is equal before the law; that laws must be predictable and known to all; and that laws must be fair and apply equally to the government as well as to those it governs. This includes the openness of courts, judicial independence from government and the presumption of innocence. English common law and equitable principles are the foundation of Australian laws.

58. The Australian court system has two arms: Federal and State/Territory. The constitution provides that the judicial powers of the Commonwealth are vested in the High Court of Australia. High Court judges are appointed by the Governor-General in Council, after extensive consultation and upon the basis of merit. Australian State and Territory courts have original jurisdiction under all matters brought under State or Territory laws and in other matters where the jurisdiction has been conferred on the courts by the Commonwealth parliament. Only a court may exercise the judicial power and examine the question of whether a person has contravened a law of Parliament.

The insolvency regime

59. The provisions of the Corporations Act that deal with corporate insolvency are primarily concerned with efficient procedures for the winding up of companies, the orderly realization of available assets of those companies and the equitable distribution of the proceeds to creditors, employees and shareholders. There are also provisions governing the appointment of receivers or other persons who are entitled to assume control over particular assets of the company; the reconstruction of companies; arrangements and compromises with creditors; and the voluntary winding up of solvent companies.

60. There are three types of external administration of insolvent companies: liquidation, receivership and voluntary administration. A company comes under external administration when its directors must relinquish direction of its affairs to a receiver, administrator, provisional liquidator or liquidator. Directors have to consider the options for external administration because they are under a legal obligation to cause an insolvent company to cease trading. If they fail to do so they may be held personally liable for the company’s debts.

61. The ASIC Act and Corporations Act and the cooperative arrangements operated by ASIC and APRA provide a sound basis for investigating and resolving problems in financial markets and financial intermediaries.

Accounting and auditing

62. From January 2005, Australia adopted International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). Some Australian-specific accounting standards have been retained to deal with particular issues, such as disclosure of director and executive remuneration, and concise financial reports.

63. A listed company is required to lodge with ASIC annual and half-yearly financial reports. The financial statements must be prepared in accordance with IFRS and must provide a true and fair picture of the entity’s financial position and performance. The annual accounts must be audited, with the half-yearly reports subject to either review or audit. Large non-listed companies are required to lodge annual statements with ASIC. ASIC has granted some relief to compliance with accounting standards to non-listed companies which are defined as “non-reporting companies”. Exemptions from reporting requirements are also provided for small non-listed companies.

64. The accounting profession in Australia is well established and recognized as being of a high international caliber. In order to audit a listed company’s financial report, the auditor must be registered under the Corporations Act. In order to be registered, ASIC must form an opinion that the applicant has the necessary qualifications, satisfies the auditing competency standard and is capable of performing the duties of an auditor. Oversight of auditors is provided by ASIC and the professional accounting bodies. Disputes over the behavior of auditors are decided by the Companies Auditors and Liquidators Disciplinary board. There are currently 6110 registered auditors. Auditing standards in Australia are established by the Auditing and Assurance Standards Board (AUASB), and are based on International Standards on Auditing (ISAs). The Financial Reporting Council oversees the AUASB and the AASB.

E. Principle-by-Principle Assessment

Principles related to the regulator

65. Although currently operationally independent and appropriately funded there are several issues concerning the independence of ASIC, which should be resolved. Consultation on new regulatory issues is presently extensive but there may be a case for the authorities and the private sector working together to improve even further its effectiveness.

Principles related to compliance and enforcement

66. Apart from the acknowledged weakness in the AML/CFT area, where Australia legislation has failed to keep pace with the latest international developments (and where change is imminent), the powers given to ASIC under the law are comprehensive and ASIC’s use of them is effective and credible.

Principles related to information sharing and cooperation

67. As a signatory to the IOSCO Multilateral MOU (MMOU) for the exchange of information ASIC’s commitment to the highest standards in this area is undisputed. Improvements as to timeliness have already been identified as necessary by the authorities and change is imminent. Subject to review of the effectiveness of those changes, further improvement may prove necessary.

Principles related to issuers

68. The mix of corporate law and securities regulation appears to work well. ASIC is frequently called upon to facilitate takeover bids via use of its exemptive relief powers as well as to prevent misbehavior. It would be helpful to the market, however, if ASIC were to collate and publish the advice it has given in recent years on prospectus disclosure.

Principles related to collective investment schemes

69. Operators of collective investment schemes are subject to a comprehensive licensing system and to risk-based supervision. Greater specificity could usefully be introduced into the provisions governing the conduct of fund managers when trading on behalf of their clients. The ongoing record of the industry regarding unit pricing errors should be monitored closely to see whether the guidance recently published by ASIC and APRA has, in fact, minimized what has clearly been a major and longstanding problem.

Principles related to market intermediaries

70. Market intermediaries are subject to a comprehensive licensing system and risk-based supervision. Detailed regulations govern the firm/client relationship but ASIC’s risk-based capital requirements do not fully match international best practice

Principles related to secondary markets

71. The Minister is responsible for licensing exchanges (market operators) and clearing and settlement facilities (CSFs); their rule changes must be submitted to him and are subject o a disapproval process. In practice, day-to-day supervision is carried out by ASIC, which also conducts an annual review of their compliance with their obligations. It may, therefore, be appropriate to review the original case for the Minister retaining these powers. ASIC’s risked-based capital requirements for large exposures are not sophisticated enough for an OTC market of growing size and complexity.

Table 7.

Principle-by-Principle Assessment of Observance of the IOSCO Objectives and Principles

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Table 8.

Summary Implementation of the IOSCO Objectives and Principles

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Recommended actions and authorities’ response to the assessment

Table 9.

Recommended Plan of Actions to Improve Implementation of the IOSCO Objectives and Principles

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Authorities’ response

Introduction

The authorities welcome the comprehensive assessment of Australian securities regulation as part of the IMF’s Financial Sector Assessment Program. The authorities consider that the assessment reflects a high degree of compliance with the IOSCO objectives and principles of securities regulation. Australia is already taking steps to implement some of the recommendations and is carefully considering the others to ensure optimal compliance with the IOSCO objectives and principles.

Independence of the regulator

ASIC has complete independence in relation to the performance of its functions and exercise of its powers under the corporations legislation. While the IOSCO principles require an additional degree of autonomy in relation to regulatory policies and funding, it is difficult to reconcile the IOSCO approach to independence with notions of ministerial accountability. The Australian Government considers that IOSCO should reconsider its approach to this principle. The principle should focus on independence in the administration of the regulatory framework as it relates to specific cases, rather than requiring absolute strategic and financial autonomy from the executive arm of Government.

In relation to the specific issues raised in the assessment, the Minister’s power to issue a direction to ASIC with respect to policies and priorities is limited. There are prerequisites to such a direction to ensure transparency and accountability. A direction may not relate to a specific matter. While the Minister may direct ASIC to investigate a matter, the conduct of the investigation is a matter for ASIC. ASIC has a high degree of flexibility in regard to the allocation of its funding across priorities. The cost recovery arrangements that fund ASIC and other elements of the corporations regulation scheme are scheduled for review in 2007. There is no intent to introduce new levies on corporations.

Funding of the regulator

In general, the Australian Government notes that its overall approach to fiscal policy over the last decade, in which all public sector spending is subject to robust discipline, has served Australia well, ensuring adequate funding for government services and agencies while producing a degree of sustained fiscal responsibility unmatched by many other OECD economies.

The Australian Government has supported ASIC’s regulatory role with significant funding increases over recent years. In the 2006-07 Budget, ASIC’s funding was increased by approximately 25 per cent, or $234.6 million over four years. The additional funding will ensure that ASIC has sufficient funding to maintain its current regulatory focus, develop its presence in relation to non-exchange based market trading (over-the-counter trading), and provide greater flexibility in funding enforcement activities.

Improving industry consultation

ASIC is endeavoring to improve the effectiveness of its consultation processes with industry and other stakeholders. To this end, ASIC released its Better Regulation ASIC Initiatives project in May 2006. It contains a number of initiatives to improve engagement with stakeholders and ensure stakeholders are effectively and efficiently consulted. Initiatives to date include establishing a Business Consultative Panel in Sydney and Melbourne and designing a standard liaison strategy that it will apply across all the regulated population.

Information sharing and cooperation

The Australian Government is addressing concerns with the timeliness in responding to requests for information from overseas regulators by transferring responsibility for the Mutual Assistance in Business Regulation Act 1992 (MABRA) to the Treasury. This will bring the operation of MABRA into the same portfolio as the regulatory agencies involved with the administration of the legislation. The transfer of responsibility is expected to be completed shortly. The Australian Government will review the new arrangements in due course.

Enforcement

The Australian Government is considering changes to ASIC’s search warrant powers, consistent with recent changes proposed for the Australian Competition and Consumer Commission.

The Australian Government emphasizes that ASIC is not the regulator of the anti-money laundering/counter terrorist financing regulation in Australia and the legislation that it administers does not give it responsibility in this area. The definition and regulation of AFSL holders is quite distinct and not relevant to the way classes of persons are, or are intended to be, regulated under the Australian anti-money laundering/counter terrorist financing (AML/CFT) regulations. The Australian Government nevertheless is commited to ensuring that the proposed enhanced AML/CFT regulatory arrangements is supported by efective co-operation as appropriate bewteen the AML/CFT regulator, AUSTRAC, and both ASIC and APRA.

Issuers

ASIC is in the process of finalising guidance on prospectus disclosure based on the draft policy statement Better prospectus disclosure released for public consultation in February 2006. It is expected that the policy statement will be finalised and released in the near future.

Collective investment schemes

There has been no identification of problems with the current regulatory arrangements relating to the conduct of managers when trading on behalf of their clients. Accordingly the need to impose further detailed requirements is not justified in terms of a regulatory impact assessment.

The authorities agree that monitoring by the regulators of compliance with accurate unit pricing obligations is important. It is also important for continuing work to be done with industry in tackling the root causes of unit pricing error which often relate to reliance on ageing computer software platforms. Policy work is currently under way to determine the most effective method to tackle impediments to the transfer to modern systems that permit timely and accurate unit price calculations.

Compensation arrangements

A mandatory requirement for Australian financial services licensees to have appropriate compensation arrangements to meet their obligations under the Corporations Act takes effect on 1 July 2006.

Reciprocal arrangements between ASIC and APRA

The Australian Government considers the current arrangement that requires ASIC to consult APRA on the impact of the imposition, variation or revocation of an AFSL is satisfactory as it relates to consultation by ASIC on the effect on an existing authorisation of an ADI by APRA. ADI authorisation will necessarily precede an application to ASIC for an AFSL which would make a reciprocal consultation obligation on APRA unnecessary.

Risk-based capital requirements

The Australian Government will consider imposing risk based capital requirements in relation to the systemic risks arising from OTC derivatives trading, as part of ongoing policy oversight of market regulation.

Secondary market regulation

Under the Corporations Act 2001, the Minister has the power to licence financial markets in Australia. Before making any decision to grant a financial market or clearing and settlement facility licence the Minister is required to consider the advice of ASIC and as a matter of practice will also consider departmental advice. The Minister’s involvement in the decision making process ensures that market and clearing and settlement facility licences are considered from a broad public policy position taking into account the overall benefits and impact on the economy. The Australian Government will examine in greater detail the merits of transferring all regulatory powers in relation to financial markets and clearing and settlement facilities to ASIC before making any decision to change the current arrangements.

IV. CPSS Core Principles for Systemically Important Payment Systems

A. General

72. This assessment of the payment systems in Australia was undertaken in the context of the IMF Financial Sector Assessment Program (FSAP) exercise for Australia in December 2005. It covers the Reserve Bank Information and Transfer System (RITS) that settles transactions on a real time gross settlement (RTGS) basis.

73. The Reserve Bank of Australia (RBA) conducted a comprehensive self-assessment of RITS’ observance of the Core Principles for Systemically Important Payment Systems (CPSIPS). It was professionally done and was made available to the mission in advance. The Australian authorities were fully cooperative, and all relevant documentation to fulfill the assessment of RITS was provided on time and without difficulties. The logistical support and warm hospitality of the officials of RBA are greatly appreciated.

B. Information and Methodology Used for Assessment

74. The methodology for the assessments was derived from the Guidance Note for Assessing Observance of Core Principles for Systemically Important Payment Systems of the IMF and the World Bank of August 2001. Prior to the mission, the RBA prepared the self-assessment and filled in the Questionnaire on Payment and Securities Settlement Systems. Much of the material in RBA’s self-assessment has been incorporated into this assessment. Furthermore, the assessor studied laws, articles, brochures, guidelines, data, and attended presentations provided by RBA and the different private sector institutions. Moreover, the assessor had regular and thorough discussions with relevant public authorities and met representatives from the private and commercial sector.

C. Institutional and Market Structure—Overview

75. The RBA is the central bank in Australia. It operates under the Reserve Bank Act 1959, and most of its powers and functions in the payments system derive from that Act and the Payment Systems (Regulation) Act 1998. The power to determine the RBA’s payments system policy and oversight resides with the Payments System Board (PSB), one of the two boards of the RBA established under the Reserve Bank Act. The Governor of the RBA chairs the PSB. The PSB is composed of one RBA appointee, an appointee from the Australian Prudential Regulation Authority and up to five other members. The PSB’s mandate is set out in the Reserve Bank Act. It is responsible for determining the RBA’s payments system policy in a way that will best contribute to controlling risk in the financial system and promoting efficiency and competition in the market for payment services, consistent with overall stability of the financial system. The PSB’s policies are implemented by the RBA’s Payments Policy Department, which also acts as advisor to the PSB.

76. The Australian Prudential Regulation Authority (APRA) is responsible for supervising deposit-taking institutions such as banks, credit unions, and specialist credit card institutions, which are participants in the payments system and offer payment services.

77. The Australian Securities and Investments Commission (ASIC) is responsible for market integrity and consumer protection across the financial system, including payments transactions. It administers the Corporations Act 2001 and regulates Australian corporations, financial markets, clearing and settlement facilities (in conjunction with the RBA), and financial service providers.

78. The RBA also sets Financial Stability Standards that are to be complied with by clearing and settlement systems. Accordingly, the RBA and ASIC have agreed on a Memorandum of Understanding in relation to clearing and settlement facilities that sets out a framework for their cooperation.

79. The Australian Competition and Consumer Commission (ACCC) is responsible for ensuring that payments system arrangements comply with the competition and access provisions of the Trade Practices Act 1974. This authority can exempt the conduct of organizations and arrangements from the competition provisions if it judges it to be in the public interest. The ACCC and the RBA have also signed a Memorandum of Understanding to ensure a coordinated policy approach.

80. The Australian Payments Clearing Association (APCA) administers SWIFT payments and is responsible for coordinating the clearing of most retail payment instruments such as checks, direct entry, ATMs, and some card payments. APCA is a limited company owned by its shareholders such as banks, some building societies, credit unions and the RBA. Other payments clearing systems independent of APCA include MasterCard, Visa and Bankcard, and the BPAY system for payment of bills.

D. Payment Systems Infrastructure

81. RITS is the only systemically important payment system that operates in Australia. It was introduced as a real-time gross settlement system in June 1998 and is owned and operated by the RBA. Transactions are processed and settled continuously and irrevocably in real-time. It accepts payment instructions for interbank payments and for the settlement of net clearing arrangements. Low value transactions can also be processed through RITS. Final settlement of obligations between RITS participants is executed by entries to their exchange settlement accounts (ESA) at the RBA. The bulk of large value interbank transfers is channeled through the SWIFT network,4 and a smaller number of transactions are transmitted via the proprietary network infrastructure.

82. RITS accepts payment instructions for interbank payments and for the settlement of interbank obligations arising from net clearing arrangements, such as the net balances of interbank obligations arising from low-value payments transactions (on a next day basis) and those transactions arising from equities settlement in the ASX’s Clearing House Electronic Sub-register System (CHESS). RITS also settles on a real-time gross basis the cash leg of the securities transactions of the Austraclear settlement system.

83. There is no minimum amount for a payment to be made through RITS, so it handles time-critical low-value payments as well as large-value transfers. In 2005, RITS had 60 participants and on average settled 24,000 transactions daily with an average daily value of $A 150 billion. The flows of payments in RITS are concentrated in a relatively small number of banks, so that the four major banks have 67 percent of the volume and value of the total RTGS transactions. However, no bank acts as a major settlement agent for other banks. In total, agency arrangements account for less than 1 percent by value of transactions.

84. Cash transactions are still the most important payment instrument for small retail transactions and for transfers of value between individuals. The ready availability of cash through automated teller machines (ATM) has sustained its use. As an indication, withdrawals from ATM average $A 10.9 billion a month in 2004-2005, which equates to around $A 540 per person. Non-cash payments account for most of the value of payments in the Australian Economy. On average, non-cash payments worth more than $A 170 billion are made each business day, equivalent to about 20 percent of GDP. Check payments are still widely in use; they account for around 5 percent of the value of non-cash payments. However, the use of checks is much lower in Australia than the United States and continental Europe, but it is still much higher than the Scandinavian countries. As a consequence of the declining importance of checks, the use of electronic payment instruments at the retail level has been growing rapidly. In 2004-2005, credit and debit cards transactions averaged 112 per person. After a period of reluctance on the part of the consumers, the use of direct entry payments is growing strongly, and accounts for about 15 percent of the value of non-cash payments. The payment infrastructure for electronic retail payment is highly developed and seems to be efficient for its users, although it is relatively costly. Most banks charge their customers a so-called “foreign fee” averaging $A 1.50 per transaction when using another bank’s ATM. However, the transaction fees for using payment cards for EFTPOS transactions have fallen in recent years.

85. At present, 25 locally-owned banks, 28 branches of foreign banks, and more than 150 credit unions are active in Australia, of which 53 banks and branches are participants in RITS.5 The RBA preferred to have a broad participation in RTGS in order to reduce risk concentration in a few banks and, as a matter of policy, all banks were required to make their own high value payments in the RTGS system using their own account at the central bank. This policy was relaxed in March 2003 to allow very small central bank account holders (less than 0.25 percent of total payments) to enter into agency relationships with other participants.

E. Legal and Regulatory Framework

86. The Reserve Bank Act and the Payment Systems (Regulation) Act empower the RBA to oversee payment systems operated in Australia as well as fulfilling several payments related tasks. The power to determine and carry out the policy of the RBA in the field of payment systems resides with the Payments System Board (PSB) and its mandate is defined in the Act. The PSB is responsible for determining the RBA’s payments system policy in a way that “will best contribute to controlling risk in the financial system; promoting the efficiency of the payments system; and promoting competition in the market for payment services, consistent with overall stability of the financial system.”

Table 10.

Assessment of RITS Observance of the CPSIPS and the RBA Responsibilities

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Table 11.

Summary Observance of CPSS Core Principles and Central Bank Responsibilities in applying the CPSIPS—RITS

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F. Recommended actions and authorities’ response to the assessment

Recommended actions

Table 12.

Recommended Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in applying the CPSIPS—RITS

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Authorities’ response

The authorities are grateful to have had Australia’s only systemically important payment system, the Reserve Bank Information and Transfer System (RITS), reviewed by the IMF. The review was conducted professionally and cooperatively and the authorities found the process useful. The authorities concur with the IMF’s assessment that RITS complies with all of the Core Principles for Systemically Important Payment Systems and that oversight arrangements comply with the responsibilities of the central bank in applying the Core Principles.

With regard to the specific recommendations arising from the assessment, an upgrade to the RITS user interface was well advanced at the time of the assessment and is due for implementation during 2006. This upgrade will bring confidentiality, integrity and authenticity of transmitted information up to best practice. Also during 2006, the Reserve Bank will finalize a review of pricing. In determining any changes to fees, the Bank will take into account cost recovery, system efficiency and appropriate incentives for participants, along with industry feedback on proposed changes. The Bank will continue to ensure that the appropriate delineations are maintained between the oversight functions carried out under the responsibility of the Payments System Board and operational payments functions. It will ensure that any conflicts of interest that may arise in the oversight process are properly addressed.

The Reserve Bank will give careful consideration to the IMF’s recommendations in relation to legal risk from branch participation in RITS, external review of the RITS business continuity plan, and arrangements for consultation with RITS users. The Bank will also consider how best to perform its oversight function.

1

Michael Andrews (IMF-MFD Consultant) and Göran Lind (Sveriges Riksbank).

2

The terms bank and ADI are generally used interchangeably in this assessment, although in some contexts it will be clear that only banks and not other ADIs are being referenced.

3

Richard Britton, external technical expert to the IMF

4

The Australian Payments Clearing Association (APCA) administers the closed user group and contractual arrangements governing access. These arrangements are set out in the form of regulations referred to as the High Value Clearing System (HVCS).

5

Non-bank deposit-taking payment service providers are eligible to hold ESAs and participate in RITS, but historically have participated indirectly through special service providers that are RITS participants. Other RITS participants include CLS Bank and entities associated with the Australian Stock Exchange and the Sydney Futures Exchange.

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