Personal Property Securities Reform Discussion Paper

Transcription

1 24 October 2008 Personal Property Securities Branch Attorney-General s Department Robert Garran Offices National Circuit BARTON ACT 2600 By pps@ag.gov.au Dear Mr Glenn Personal Property Securities Reform Discussion Paper The Australian Financial Markets Association (AFMA) is pleased to take this opportunity to make comment on the Personal Property Securities Reform Discussion Paper which advises on regulation to be made under the Personal Property Securities Bill. In its submission of the 15 August 2008, AFMA provided views on the Personal Property Securities (PPS) reform process and concerns with the number and range of potential issues about the practical operation of the Bill. The concerns flowed from views of legal experts who advise AFMA members and have the detailed experience and knowledge to make informed commentary on the Bill and its serious jurisprudential ramifications. We continue to be of the view that the best approach, which is consistent with the Council of Australian Governments agreement to reform Australia s personal property securities law, and establish a single online national system for registering personal property securities to enable instantaneous checking for encumbrances on personal property, is to focus on the core registry aspects of the proposed regime. This is most likely to yield tangible positive results for business in the near term, with other matters relating to the radical revision of Australian securities law being done over a longer period to minimise cost and disruption to business. Our members experience with major regulatory reforms such as financial services reform, anti-money laundering and GST is that it takes a long period of analysis and consultation for stakeholders (including government and regulators) to fully appreciate the practical impacts of proposed changes and to develop a legislative and regulatory solution that will deliver the desired outcome in the least cost/most efficient way. PPS reform is no different in this regard. In concert with our earlier submission, we continue to emphasise the importance of providing further and sufficient consultation opportunities on the revised draft Bill and that the review and implementation of the proposed changes be managed in a phased manner. Australian Financial Markets Association ABN Level 3, 95 Pitt Street Sydney NSW 2000 Tel: (61 2) Facsimile: (61 2)

2 Comments on Discussion Paper Comments in this submission are confined to those matter in the Discussion Paper which are deemed relevant to the concerns of AFMA members. Section 19 Definition of business day Question Are there any other days that should be prescribed as not being a business day for the purposes of the Bill? The definition of business day should be consistent with that used in the Corporations Act Namely that a business day means "business day" means a day that is not a Saturday, a Sunday or a public holiday or bank holiday in the place concerned. Accordingly, the proposed definition should be expanded to include a bank holiday. Section 19 Details about a person Question Comment is invited as to whether the above rules cover all entities against which PPS registrations might be made, and whether the information required would be sufficiently particular to identify grantors and secured parties It is the stated intention that the regulations will prescribe how grantor and secured party details would be recorded on the PPS register. The Discussion Paper raises the issue of whether information should be recorded pursuant to the AML-CTF requirements. It is important that regulatory requirements across legislation should be consistent and not create separate or conflicting obligations where similar regulatory outcomes are intended. The policy objective is to identify with certainty parties recording interests on the register. The Attorney-General s Department after very significant collaboration with industry has developed an effective identification regime under the AML-CTF rules and industry has incurred large costs in implementing these rules and complementary due diligence practices. These identification rules are now an Australian community standard that provide a ready made and increasingly familiar identification framework that should be leveraged off for other statutory purposes such as the PPS register. To do otherwise would impose regulatory complexity and unnecessary costs on business. Section 19 - Definition of investment instrument The Discussion Paper notes that at this stage it is not proposed that a regulation would be made to prescribe financial products additional to those currently set out in section 19 of the Bill and that the precise financial products that should be included in the definition will be determined after further work has been undertaken on the definition of investment instrument generally. As we noted in our submission on the Bill, the proposed definition does not reflect the scope of the definitional concepts in Chapter 7 of the Corporations Act For example, while the definition includes a share in company and interests in a registered scheme (within the meaning of that Act), it would not include fractions of those instruments (eg equitable interests in fund units or fractional shares) or accretions to those (eg renounceable rights) that are covered in section 761A and section 764A. 2

3 The definition should include: Derivatives that are not trades on a financial market (ie OTC derivatives); Debentures and other debt securities that are not a quoted security; Investment entitlements as defined in section 50 (noting this definition may be refined to reflect language in the Hague Convention in light of feedback); Accretions to investment interests such as rights issues; Foreign exchange contracts which are not derivatives; Units in a trust which is not a registered managed investment scheme; Australian Emissions Units (AEUs) in contemplation of the commencement of the Carbon Pollution Reduction Scheme in 2010; 1 and Interests arising in any investment instruments in the expanded list. In addition, clarification is required to ensure that the protection of the Payment Systems and Netting Act 1998 is not impaired by the Bill. Section 21 Meaning of security interest While we recommend the need to specifically include the above financial products in the definition of investment instrument it is necessary on the other hand to explicitly exclude securities lending from the scope of the security interest definition. The scope of the legislation as a matter of policy should not interfere with the ability to efficiently conduct business on financial markets. Securities lending play an important part in the efficient functioning of securities markets around the world. Securities lending arrangements refer to the common market practice whereby securities are temporarily transferred by one party (the lender) to another (the borrower). The borrower is obliged to return equivalent securities to the lender, either on demand, or at the end of an agreed term. For the period of the loan, the lender is secured by acceptable assets delivered by the borrower to the lender as collateral. Under Australian law, absolute title to the securities lent passes to the borrower who is obliged to return equivalent securities. Similarly the lender receives absolute title to the assets received as collateral from the borrower, and is obliged to return equivalent collateral. To assist with your consideration, the following is a brief description of the legal framework surrounding securities lending. In general, it is possible to view a securities lending transaction as being a financial product on the grounds that it is a derivative, as defined, even though it might not traditionally be thought of as a derivative. Derivative is defined in section 761D of the Corporations Act as an arrangement in relation to which the following requirements are satisfied: 1 AEUs will be a market traded product and derivatives based on AEUs may be deliverable. The Green Paper preferred position is to treat AEUs as financial products under Chapter 7 of the Corporations Act. 3

4 (a) party to the arrangement must, or may be required to, provide consideration at some future time (being generally not less than 1 business day); and (b) the amount of consideration or the value of the arrangement is ultimately determined, derived from or varies by reference to, the value or amount of something else (such as an asset, a rate, an index or a commodity). The term is intended to embrace financial contracts such as futures, options, warrants, swaps, share ratios and other synthetics. A securities lending transaction is considered to be a derivative on the basis that: (a) the borrower is required to provide consideration at a future time (ie equivalent securities and, importantly, manufactured payments and any non-cash rights); (b) the amount of consideration for the initial lending leg (ie the promise to redeliver equivalent securities and also to make manufactured payments and provide the value of non-cash rights), or value of the arrangement, may vary by reference to something else: at the very least the value of the manufactured payments and any non-cash rights varies by reference to the distributions and non-cash rights that arise in respect of the identical securities to the lent securities; and (c) the agreement of the borrower to make manufactured income payments and also (in the case of equity securities) to compensate the lender for any non cash rights brings a securities lending transaction within the statutory definition. Initially, securities loans were typically negotiated between counterparties on the telephone, with written or electronic confirmations being sent subsequently. Normally the borrower initiates the call to the lender, with a borrowing requirement. However pro-active lenders may also offer out securities that they know are in demand in the market to their approved counterparties. Particularly if one borrower returns a security and the lender is still lending it to others in the market, the lender will contact the borrower to see if it wishes to borrow additional securities. Nowadays, there is an increasing amount of bilateral and multilateral automated lending whereby securities are broadcast as available at particular rates by using or other electronic means. Where lending terms are agreeable, automatic matching can take place. Written or electronic confirmations are issued, whenever possible on the day of the trade, so that any queries by the other party can be raised in a timely manner. Material changes during the life of the transaction are agreed between the parties and may also be confirmed if either party wishes it. The parties agree who will take responsibility for issuing loan confirmations. In Australia, the standard industry document is the Australian Master Securities Lending Agreement (AMSLA) of the Australian Securities Lending Association (ASLA) published through the AFMA s On-Line Guide to OTC Documents. It can be used for debt, as well as equity, securities. Australian lenders normally require the second leg (i.e. the return of equivalent securities) taking place within 12 months of the settlement date 4

5 under the first leg of the relevant securities lending transaction. However, so long as the necessary equivalent securities have been transferred to the lender or its custodian within that period, they can be relent immediately, including to the same borrower. For equity securities the Australian Stock Exchange s CHESS system permits loans of listed securities and returns of equivalent listed securities to be settled either on a delivery-versus-payment (DvP) basis (the payment can be set at zero), in a manner similar to a sale, these settle once a day or on a free of payment basis when they settle on demand. Typically, in the case of a free of payment demand transfer, cash will move via a totally separate transaction on Austraclear later in the business day. Counterparties keep their own daily records of securities on loan, the mark to market valuation of those securities, and required collateral movements and agree those collateral movements with each other each business day morning. For debt securities Commonwealth Government debt securities are now held in the Austraclear system. Most State Government, semi-government and corporate debt securities are also held in the Austraclear system. Debt securities held in the Austraclear system can be transferred on a DvP basis. Delivery of the debt security occurs in the Austraclear system with simultaneous payment occurring through a link between Austraclear and the Reserve Bank of Australia s real time gross settlement system (RITS). In a principal program with a custodian bank, the lender is concerned with the credit worthiness and the insolvency risk of the custodian and the custodian is a good credit risk collateral may not be required. In this case, the client monitors and regularly reviews the custodian s credit rating and the limit and actual exposure applicable to it. In an agency program, the legal relationship is between the lender and the person to whom the agent has lent the securities. Accordingly, it is the borrower (and not the agent) who is the counterparty. In an agency program, a lender s risk exposure is minimised by an appropriately drafted set-off or close out netting provision in the relevant master agreement. Where governed by Australian law the Payment Systems and Netting Act 1998 gives statutory force in Australia to the effectiveness of close out or market netting provisions before any insolvency of a counterparty. Section 50 Application of law in relation to security interests in investment entitlements The discussion paper refers to section 50 of the Bill and that for the purposes of the meaning of investment entitlement the definition of financial product will be relevant. In relation to the further work being done on this definition we refer to our comments above which are also relevant here. Concluding remarks We look forward to continuing to collaborate through the Working Group process with the Attorney-General s Department in further consultations around the development of the draft Bill. We consider that the PPS reforms will have a significant commercial impact resulting in unanticipated costs to business flowing from the far-reaching overhaul of legal principles governing securities transactions. 5

6 Unfamiliarity with new legal concepts will create an environment of legal uncertainty for business during a transitional period which could last for some time. Both before and during the implementation and bedding phases for the new PPS regime it will be essential to maintain a continuing dialogue between government and business to address operational problems, confusion and unintended consequences. We look forward to working with you during this development period to provide advice and assist with developing solutions to enable a successful reform process to take place. Yours sincerely David Love Director - Policy 6