On 30 November 2021, the Australian Law Reform Commission (ALRC) released its first Interim Report, setting out its initial recommendations, proposals and questions for the reform of financial services law.
The ALRC inquiry was set up to address concerns about the financial services regime raised by the Financial Services Royal Commission. As the Royal Commission noted: 'the more complicated the law, the harder it is to see unifying and informing principles and purposes'.
The need for reform
The content and structure of corporations and financial services law has long been regarded as being unnecessarily complex and in need of simplification. Not only does the Corporations Act extend to nearly 4,000 pages, it is accompanied by regulations, legislative instruments, regulatory guides and reports that taken together, pose significant challenges to the navigability of the law.
The first ALRC report
This first ALRC report (Interim Report A) is primarily concerned with the use of definitions in corporations and financial services. As a result, a number of its recommendations are very technical. However, the report also contains a number of significant proposals and questions about further areas for reform.
Proposals
The ALRC makes a number of proposals and poses questions regarding other areas of reform with the aim of reducing regulatory burden on the industry, improving consumer understanding of the law and ensuring greater consistency with the rule of law.
Boundaries
The ALRC proposes to apply an 'It’s in, unless it’s out' approach to determining the scope of the financial services regime. This would involve removing the list of included products from the definition of financial products in the Corporations Act and the ASIC Act. This approach trades off the certainty of the included list of products against the simplicity of broad concepts.
The ALRC makes a number of related proposals relating to definitions:
- Use the same definitions of 'financial product' and 'financial service' in the Corporations Act and the ASIC Act.
Different definitions are currently used because ASIC’s powers to regulate financial services and products is meant to be wider than the reach of the licensing and disclosure regime in the Corporations Act. The ALRC proposes to address this by the use of application provisions where relevant to particular obligations.
- Remove certain functional definitions
This is to allow the terms to have their ordinary meaning: ‘makes a financial investment’, ‘manages financial risk’ and ‘makes non-cash payments’.
While this proposal has merit, it has the potential to significantly expand the reach of the financial services regime.
- Replace the incidental exclusion with specific exclusions, such as excluding warranties.
This is quite a significant proposal as the incidental exemption is relied on in many situations. Requiring exclusions to be listed will require additional engagement with ASIC regarding products on the fringe of regulation. The proposal is also not consistent with principle-based regulation.
- A single functional definition of ‘credit’, eliminating differences between the Corporations Act, ASIC and the National Credit Code.
There does seem to be significant merit in this suggestion, noting that there are aspects of each type of product which require unique regulation.
New statutes
The ALRC notes that having a single definition of ‘credit’ could facilitate merging the financial services and consumer credit regimes. This could be done in the ASIC Act and renaming it as the Financial Services and Markets Act. The ALRC also proposes that there should be a single consolidated instrument to replace regulations and individual subject-specific instruments which will contain all exclusions and exemptions to definitions and obligations.
The purpose of this proposal is to address the lack of transparency and the complexity of the current regulatory structure. The idea is that there would only be one place to look for exclusions and exemptions and application provisions for obligations. The ALRC asks whether a power to make such an instrument in the form of ‘rules’ should be included in the Corporations Act and whether ASIC should have the power to make such ‘rules’.
Reforms of fundamental obligations
The ALRC has made a number of proposals which relate to the fundamental obligations in the financial services regime. These proposals include:
- Separate the efficient, honest and fair obligation into three separate obligations.
- Replace ‘efficiently’ with ‘professionally’. The ALRC notes that the alternative to ‘professional’ would be ‘competent’ (used in HK regulation) but favours ‘professional’ (used in European regulation) claiming the terms are synonymous.
- Include non-exhaustive examples of unfair conduct in the legislation to address concerns regarding the uncertainty and potential breadth of a separate fairness obligation.
- Introduce norms of conduct in the objects of the financial services regime to assist with interpretation of the regime but not make them directly enforceable. The ALRC has said that it is not necessary to make the norms enforceable because the efficiently, honestly and fairly obligation is now a civil penalty provision. Specific norms are not identified beyond those identified by the Financial Services Royal Commission. The ALRC has also indicated that future reports will consider the extent to which general law obligations (such as fiduciary duties) could or should be codified or referred to in financial services regulation.
- Remove the ‘prescriptive’ general licensing obligations relating to management of conflicts of interest, maintaining competence, training of representatives and risk management systems on the basis they are redundant given the understood meaning of ‘efficiently’.
It appears odd to regard these obligations as being ‘prescriptive’ given their general nature. It also seems odd to remove such key obligations and to rely instead on requiring providers to act efficiently or professionally. These obligations do not seem to do any harm and instead provide useful minimum standards for licensees. The ALRC recognises this but says that these matters could be addressed in ASIC guidance.
- Consolidate into one set of prohibitions in one place. The prohibitions of false or misleading representations, misleading or deceptive conduct and unconscionable conduct are currently found in different places in the Corporations Act and ASIC Act.
Product disclosure
The ALRC proposes to reframe product disclosure to incorporate an outcomes-based standard of disclosure. The standard would be developed through further consultation.
For example, the standard could require issuers to take reasonable steps to ensure that a reasonable consumer, and their financial adviser where appropriate, understands the key risks, costs, and benefits of the product at the time of investment. The standard would be appropriately supplemented by more detailed requirements where prescription is required, such as in relation to standardised disclosures of fees and costs and for particular products.
It is interesting that the example provided is of an investment which demonstrates the difficulty of developing a standard suitable for all types of product. Such an approach would be consistent with the move from buyer beware to seller beware that we have increasingly seen in financial services regulation – the Design and Distribution Obligations (DDO) regime is an example of this. It is also consistent with a principle-based approach but could significantly increase uncertainty for issuers.
Retail client test
The ALRC also asks whether the definition of ‘retail client’ should be simplified by removing the specific general insurance, superannuation and traditional trustee company definitions and the product value ($500,000) and asset ($2.5m) and income ($250,000) tests.
This would mean that a person is a retail client unless they are a professional investor, meet the experience test or are a business other than a small business.
The ALRC identifies the following concerns regarding the current definition:
- the asset and income thresholds are out of date in view of increasing asset values
- experience suggests that persons who meet the asset or income test cannot be presumed to have the requisite knowledge to make an informed decision, and are no more inclined to acquire appropriate financial advice than other retail clients
- hesitation on the part of AFS Licensees to apply the ‘sophisticated investor’ exception – the ALRC therefore asks what improvements could be made to this exception
- providers are often incentivised to characterise clients as wholesale clients
- case law has identified challenges with the interpretation and application of the definition
- there are inconsistencies in the definition of ‘small business’ across statutes and codes.
The ALRC also notes the inconsistency between the approach adopted in the Corporations Act retail client test and the definition of ‘consumer’ in the ASIC Act and the consumer credit regime. It suggests that greater alignment of definition and terminology would be appropriate and invites views on how this could be achieved.
The ALRC also notes the different approach adopted in relation to securities and indicates that this will be considered in subsequent reports.
Personal advice
The ALRC asks whether the best interests duty should be reformed by:
- changing s961B(2) of the Corporations Act from being a safe harbour to ‘indicative behaviours of compliance’ which a court must have regard to when determining whether the general duty in s961B(1) has been satisfied, and
- removing the definitions of ‘reasonably apparent’ in s961C and ‘reasonable investigation’ in s961D.
In other words, advisers would simply be required to act in the best interests of clients. The purpose according to the ARLC would be to promote more meaningful compliance rather than ‘tick-a-box’. It recognises that the last limb of s961B(2)(g) – to take any other step that would reasonably be regarded as being in the client’s best interests – is open-ended and means the provision may not effectively be as a safe harbour in any case. It is not clear what this would mean for banking or general insurance products.
The ALRC also proposes to remove ‘personal advice’ from the concept of ‘financial service’ so that it is clear when personal advice is being regulated and when it is not.
This is one of a significant number of very technical drafting recommendations and proposals of the ALRC report.
Recommendations
The ALRC starts its report with the following 13 very technical recommendations which it claims will simplify and improve the use and design of definitions:
- Remove reference to the non-existent Part 1.3 of the Corporations Act in the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act).
- Remove the definitions of all words and phrases that are not used as defined terms in the Corporations Act.
- Remove all qualifications that definitions or rules of interpretation apply unless a 'contrary intention appears'.
- Remove the definitions of 'for' and 'of' in the Corporations Act.
- Repeal section 5C of the Corporations Act and section 5A of the ASIC Act (concerns the application of the Acts Interpretation Act 1901 (Cth) (Acts Interpretation Act)).
- Remove all definitions in the Corporations Act and ASIC Act that duplicate existing definitions in the Acts Interpretation Act.
- Include a single glossary of defined terms in the Corporations Act.
- Replace section 7 of the Corporations Act with a provision that lists where dictionary definitions appear and the scope of their application.
- Include the word 'definition' in the heading of any provision in the Corporations Act that defines one or more terms and does not contain substantive provisions.
- The Office of Parliamentary Counsel to develop drafting guidance to draw attention to defined terms each time they are used in corporations and financial services legislation.
- The Office of Parliamentary Counsel to investigate the production of Commonwealth legislation using extensible markup language.
- The Office of Parliamentary Counsel to commission further research to improve the user-experience of the Federal Register of Legislation.
Other questions
In addition to the questions noted above, the ALRC asks the following questions:
- Would definitional principles be useful? The principles would be used to determine when and how terms should be defined.
- What additional data should the ALRC analyse?
Next steps
The ALRC's proposals could involve a significant reshape of financial services law and have as big an impact as the introduction of Chapter 7 of the Corporations Act in the Financial Services Reform Act following the Wallis Financial System Inquiry.
Submissions on this first interim report are due by 25 February 2022.
Two more interim reports are also scheduled to be released before the Final Report which is due 30 November 2023.
Links to key material:
