Substituted Compliance: An Australian Regulator s Perspective

Transcription

1 HARVARD ILJ ONLINE VOLUME 48 - FEBRUARY 5, 2007 Substituted Compliance: An Australian Regulator s Perspective Greg Tanzer * I. INTRODUCTION The forces of change affecting the U.S. regulatory environment described in Ethiopis Tafara s and Robert Peterson's article A Blueprint for Cross-Border Access to US Investors: A New International Framework ( the Blueprint ) 1 are challenging regulators across the world. The Australian Securities and Investments Commission ( ASIC ) has been developing an approach to regulating cross-border trade in financial services, and this has found expression in a number of ASIC policy statements. 2 This commentary, which explores possible approaches to such forces of change, is therefore given from the perspective of a regulatory authority that has articulated a position on regulating cross-border trade and is grappling with implementing that policy. The notion of substituted compliance is a significant step in the development of a policy framework for regulating capital markets that, as the authors note, are global. 3 Overseeing stock exchanges with global links, regulating cross-border 1 Ethiopis Tafara & Robert J. Peterson, A Blueprint for Cross-Border Access to U.S. Investors: A New International Framework, 48 HARV. INT'L L.J. 31 (2007). 2 See, e.g. ASIC, Policy Statement 176, Licensing: Discretionary Powers Wholesale Foreign Financial Services Providers (reissued May 17, 2005), available at df [hereinafter ASIC, PS 176]; ASIC, Policy Statement 177, Australian Market Licences: Overseas Operators (Oct. 30, 2003), available at df [hereinafter ASIC, PS 177]; ASIC, Policy Statement 178, Foreign Collective Investment Schemes (May 31, 2004) available at df [hereinafter ASIC, PS 178]. 3 Tafara & Peterson, supra note 1, at 31. Copyright 2007 by the President and Fellows of Harvard College and Greg Tanzer

2 22 Harvard International Law Journal Online / Vol. 48 securities transactions, and deterring cross-border financial fraud are the reality for securities regulators, and it is critical that regulation take account of and move with developments in industry, especially international developments. The tools generally used to regulate domestic securities markets are not necessarily effective in responding to the challenges of cross-border trade, or indeed cross-border fraud. More significantly, as the authors clearly articulate, the philosophy and policy rationale underpinning these domestic regulatory regimes are similarly constrained. 4 A regulatory philosophy that operates solely on the premise that if you want to play in my sand pit you have to play by my rules is of limited value where investors can and do readily access alternative investment options using available technology. 5 The challenge is therefore to develop a policy framework that recognizes that local investors want to access international financial markets without domestic regulation imposing an unreasonable impediment, while ensuring that the objectives of the domestic regulatory regime and integrity of the market are not compromised. Given the competitiveness of the financial-services marketplace globally, and the speed of these developments, it is important and increasingly urgent that this challenge be addressed. To meet this challenge, there needs to be a coherent policy framework for the interaction of domestic regulation with cross-border trade, augmented by effective mechanisms for taking enforcement or other regulatory action as necessary. In my view, the policy framework set out in the Blueprint provides the basis for meeting these requirements for an effective cross-border regulatory approach. ASIC welcomes the article and the opportunity to engage in debate on this important topic. In this commentary, I will discuss ASIC s approach to regulating cross-border trade in financial services and explore the similarities and differences from the approach suggested by Mr. Tafara and Mr. Peterson. In doing so, I will reflect on both the challenges facing regulators in dealing with this area and, in particular, the need for the policy framework to be practicable. ASIC strongly endorses the notion that any system for facilitating market access must have as its basis an understanding that the home jurisdiction has a regulatory regime comparable to that of the domestic jurisdiction, both in law and in practical application. ASIC also strongly endorses the notion that an ongoing commitment to cooperation and communication in both inspection and enforcement contexts is vital. Where these fundamental conditions can be satisfied, there is a strong argument for the regulatory functions performed in the foreign jurisdiction to be regarded as compliant with the requirements of the domestic regime. II. ASIC S APPROACH TO CROSS-BORDER TRADE IN FINANCIAL SERVICES 4 Id. at Id. at 41.

3 2007 / Substituted Compliance: An Australian Regulator s Perspective 23 Australian retail investors, like their U.S. counterparts, are increasingly interested in international investment opportunities. The Australian Government has for many years recognized the benefits of opening up the Australian financial system to international competition and has been active in facilitating access to foreign financialservice providers. 6 This competition provides Australian investors with greater choice of investment options and encourages the introduction of innovative financial products. International competition also places competitive pressure on transaction costs and fees charged to investors. The opening up of the Australian financial system by way of ASIC recognizing the regulation of particular jurisdictions has not resulted in a reduction in the quality of our regulatory standards. The initial focus of the substituted-compliance article is on the development of a policy framework. 7 Then the focus shifts to the application of that framework to foreign trading screens and foreign financial-service providers and their access to U.S. financial markets. 8 ASIC adopted a similar approach, recognizing that the first phase is the development of a coherent policy framework to apply generally to marketaccess issues, rather than the development of rules to address particular products or market segments. This broad policy framework is encapsulated in ASIC's Principles for Cross Border Financial Services Regulation: Making the Regulatory Regime Work in a Cross Border Environment ( the Principles ), issued in November The general principles are as follows: 1. ASIC recognises foreign regulatory regimes that are sufficiently equivalent to the Australian regulatory regime, in relation to the degree of investor protection, market integrity and reduction of systemic risk that they achieve; 2. ASIC gives the fullest possible recognition to sufficiently equivalent foreign regulatory regimes; 3. ASIC must have effective co-operation arrangements with the home regulators of foreign facilities, services, and products available in Australia; 4. ASIC must be able to enforce the Australian laws that apply to foreign facilities, services, or products in Australia; 5. Adequate rights and remedies must be practically available to Australian investors who access foreign facilities, services, or products in Australia; 6. Adequate disclosure must be made of information that Australian investors may reasonably require to make an informed assessment of the consequences of any significant differences between the regulation of the foreign facilities, 6 Peter Costello MP, Treasurer of the Commonwealth of Austl., Keynote Address to the ANZ Asia Forum (Sept. 17, 2006), available at 7 Tafara & Peterson, supra note 1, at Id. at 54.

4 24 Harvard International Law Journal Online / Vol. 48 services, or products and the regulation of comparable Australian facilities, services, and products. 9 The rationale for focusing on the development of a broad framework as the first step in developing an approach to regulation in a cross-border environment is clearly articulated in the Blueprint. It is to ensure that facilitating the ability of international financial-service providers to access the local financial-service market is achieved without compromising key regulatory objectives or undermining regulatory standards. In the case of the United States, this is the U.S. Securities and Exchange Commission s ( SEC ) mandate as articulated in its mission statement to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. 10 ASIC shares a similar mandate. It is required by its enabling legislation to strive, inter alia, to: (a) maintain, facilitate and improve the performance of the financial system and the entities within that system in the interests of commercial certainty, reducing business costs, and the efficiency and development of the economy; and (b) promote the confident and informed participation of investors and consumers in the financial system. 11 While the development of a policy framework is a necessary first step, the challenge is then giving effect to that policy framework. ASIC's Policy Statements 176, Licensing: Discretionary Powers Wholesale Foreign Financial Services Providers ( PS 176 ), and 178, Foreign Collective Investment Schemes ( PS 178 ), represent areas of regulatory responsibility where ASIC has articulated a detailed policy based on the broad framework articulated in the Principles. Generally, a person in the business of providing financial services in Australia must hold an Australian Financial Services ( AFS ) license, issued by ASIC, unless an exemption applies. 12 PS 176 enables foreign financial-service providers to provide financial services to Australian wholesale investors without the requirement of holding an AFS license if several policy parameters are satisfied: 9 ASIC, Principles for Cross Border Financial Services Regulation: Making the Regulatory Regime Work in a Cross Border Environment, 2.1 (Nov. 2002) available at df. 10 Tafara & Peterson, supra note 1, at 45 (quoting SEC, STRATEGIC PLAN 4, available at 11 Australian Securities and Investments Commission Act 2001, pt. 1, div. 1, 1(2), available at 12 Corporations Act 2001, 911A, available at

5 2007 / Substituted Compliance: An Australian Regulator s Perspective 25 a) The particular financial services are provided in Australia only to wholesale clients; b) the particular financial services are regulated by an overseas regulatory authority; c) regulation by that overseas regulatory authority is sufficiently equivalent to regulation by ASIC; d) there are effective co-operation arrangements between the overseas regulatory authority and ASIC; and e) the [foreign financial-service provider] meets all the requirements of the relevant exemption These policy parameters can be clearly traced to the Principles themselves. Although PS 176 draws heavily on the Principles, the fact that the policy is concerned with the provision of financial services to wholesale as opposed to retail investors means that consumer protection concerns have a relatively low priority. 14 This is not the case with PS 178. The objective of this policy statement is to facilitate the offer of foreign collective investment schemes ( FCISs ) to Australian retail investors through the recognition of foreign regulatory requirements applying to those FCISs. According to PS 178, ASIC will consider granting an FCIS relief from several requirements, including having to register with ASIC, holding an AFS license, and providing Australian investors with product disclosure information that conforms to the requirements of the Corporations Act of 2001, if broad policy parameters are satisfied: [The FCIS's] home regulatory regime is, and continues to be, sufficiently equivalent to the Australian regulatory regime for registered managed investment schemes, or, for disclosure relief, its disclosure regulatory regime is sufficiently equivalent to the Australian disclosure regulatory regime; [ASIC has] effective cooperation arrangements with the FCIS operator's home regulator; and adequate rights and remedies are practically available to investors resident in Australia if the FCIS operator breaches the relevant provisions of its home regulatory regime or, for disclosure relief, its disclosure regulatory regime. 15 PS 178 also indicates that ASIC, where it grants relief to an FCIS, will impose standard conditions that promote regulatory requirements or alleviate investorprotection concerns. These standard conditions also owe their provenance to the ASIC Principles. Similarly, substituted compliance, as described in the Blueprint, would be based around a framework focused on exemption requirements (for the exchange or the 13 ASIC, PS 176, supra note 2, Id ASIC, PS 178, supra note 2,

6 26 Harvard International Law Journal Online / Vol. 48 broker dealers themselves) and regulatory preconditions. Exemption requirements are the requirements that the exchange or the broker dealers themselves have to satisfy for the SEC to grant relief, while the regulatory preconditions are the requirements to be satisfied by the home country's regulatory regime. 16 III. REGULATORY PRECONDITIONS COMPARABILITY AND EQUIVALENCE The starting premise for the granting of relief under ASIC's policy statements 176 and 178 is that the home regulatory regime is (and continues to be) sufficiently equivalent to the Australian regulatory regime for licensing financial-service providers and CISs. 17 Similarly, for an exemption to be available under the substitutedcompliance framework, the precondition is the existence of a comparable regulatory regime in the home jurisdiction. 18 Both the concept of sufficiently equivalent regulatory regime and the concept of comparable regulatory regime are aimed at providing a reliable policy basis for granting relief or an exemption in a situation where there is likely to be different regulatory practices or requirements in place in each jurisdiction. An alternative is to seek complete regulatory requirement harmonization so that any differences are removed and the same rules apply in each jurisdiction. In practice, this is difficult to achieve and may not even serve the underlying goal of removing all differences due to the complexity of cultural or business norms. The focus for assessing regulatory equivalence in Australia is on outcomes. 19 As a result, there is sufficient flexibility to recognize that different jurisdictions may impose different requirements on a regulated entity to achieve the same regulatory outcome. The difference in the structure or form of regulation should not impede relief or an exemption being granted. For example, Australian CISs are required to have a single responsible entity that is legally responsible for both the operation of the CIS and the holding of its assets, 20 rather than the manager/trustee separation that is common in many other jurisdictions. The fact that an FCIS has a separate manager and trustee does not preclude ASIC from granting relief under PS 178, provided that the outcomes of Australian investor protection, Australian market integrity, and the reduction of systemic risk in the Australian financial system are achieved. 21 In assessing applications for relief, the need to convert this principle into practice is not without its challenges. ASIC has endeavoured to address this challenge by developing criteria to assess whether a foreign regulatory regime is sufficiently equivalent. The common criteria are that the regulatory regime: 16 Tafara & Peterson, supra note 1, at ASIC, PS 176, supra note 2, ; ASIC, PS 178, supra note 2, Tafara & Peterson, supra note 1, at ASIC, PS 176, supra note 2, ; ASIC, PS 178, supra note 2, Corporations Act 2001, supra note 12, 601FB 601FH. 21 ASIC, PS 178, supra note 2,

7 2007 / Substituted Compliance: An Australian Regulator s Perspective 27 a) is clear, transparent and certain; b) is consistent with the IOSCO [International Organization of Securities Commissions] Objectives and Principles [of securities regulation] and the IOSCO CIS Principles; and c) is adequately enforced in the home jurisdiction. 22 In addition, when determining regulatory equivalence under PS 178, there is the additional criterion that the foreign regulatory regime achieves the investor protection outcomes that the Australian regulatory regime seeks to achieve. 23 Again, this criterion is not applicable in relation to PS 176, which is concerned with granting relief to foreign financial-service providers catering only to Australian wholesale investors. As the focus is on wholesale investors, consumer protection concerns are not applicable. 24 The criteria for assessing regulatory equivalence also have their origin in ASIC's Principles for Cross Border Financial Services Regulation: Making the Regulatory Regime Work in a Cross Border Environment. Principles seven to ten of this document are the equivalence principles developed specifically to assist with determining whether or not a regulatory regime is sufficiently equivalent. 25 Both policy statements provide further guidance as to the meaning of each of these criteria. For example, a clear regulatory regime is one that is easily understood, while a certain regulatory regime is one that is consistently applied. 26 Individual foreign financial-service providers or FCIS operators submit the majority of applications for regulatory equivalence. However, both policy statements contemplate that relief can be made by a regulator or other government/industry body on behalf of a particular jurisdiction. In circumstances where the applicant is the first from a given jurisdiction, it is incumbent on the applicant to provide all the information that ASIC requires when making an assessment about the foreign regulatory requirements to which the applicant is subject. 27 ASIC also has indicated that in assessing regulatory equivalence it may seek to independently verify the information provided by the applicant about its regulatory regime. 28 Notwithstanding the ASIC guidance on how to assess regulatory equivalence, it is still very difficult to make the assessment in practice. It often involves a complex comparison between an unfamiliar regulatory regime operating in a legal environment different from Australia s. This comparison may require staff with skills that are very different from those required when licensing a local firm, for example. The proposal 22 ASIC, PS 176, supra note 2, ; ASIC, PS 178, supra note 2, See ASIC, PS 178, supra note 2, ASIC, PS 176, supra note 2, ASIC, Principles for Cross Border Financial Services Regulation, supra note 9, ASIC, PS 176, supra note 2, at para ; ASIC, PS 178, supra note 2, ASIC, PS 176, supra note 2, ; ASIC, PS 178, supra note 2, ASIC, PS 176, supra note 2, ; ASIC, PS 178, supra note 2,

8 28 Harvard International Law Journal Online / Vol. 48 set out in the Blueprint whereby regulators from each jurisdiction work together to determine the extent of comparability would be a beneficial development. The substituted compliance framework in the Blueprint draws a distinction between issues to be addressed by the applicant for relief (exemption requirements) and issues to be addressed through engagement with the regulator in the home jurisdiction (regulatory preconditions). The authors, in advocating that substituted compliance be based on a comparable regulatory regime, also envisage a more interactive process than is contemplated by ASIC in assessing regulatory equivalence for the purpose of PS 176 or 178. The determination of whether the foreign regulatory regime is comparable to the U.S. regime is to occur as part of a dialogue between the SEC and the foreign regulator. Specifically, there is to be a bilateral assessment between the SEC and the foreign regulator to determine the extent to which the jurisdictions trading rules, prudential requirements, examinations, review processes for corporate filings, and other requirements are comparable. 29 The next step is for the regulators to discuss the regulatory adjustments that may need to be made to the regulatory systems to bring [them] into harmony and help ensure that no regulatory gaps or systemic risks exist. 30 The Blueprint also contemplates that in assessing whether there is a regulatory regime comparable to the United States, the foreign regulator would describe how the regulatory preconditions are satisfied. 31 Leaving differences of application aside, the concepts of regulatory equivalence and comparable regulatory regime perform an identical function. From a regulatory perspective, one can more confidently vary the local requirements when one is satisfied that local regulatory objectives will be met by the regulation that applies in the home jurisdiction. Accordingly, the precondition of a comparable regulatory regime is, in my view, a sound basis for considering some form of regulatory accommodation. The authors envisage an interactive process where the relative regulatory practices of the two jurisdictions may be modified to ensure their comparability. 32 ASIC would welcome such a process applied in Australia and the United States to achieve similar mandates. IV. EFFECTIVE COOPERATION IN INSPECTION AND ENFORCEMENT Another area where there is significant similarity between the Australian policy framework and the substituted-compliance model is in the need for strong cooperation arrangements to be in place between the regulator granting relief and the home regulator. Such cooperation is essential to ensuring that foreign operators 29 Tafara & Peterson, supra note 1, at Id. 31 Id. at Id. at 58.

9 2007 / Substituted Compliance: An Australian Regulator s Perspective 29 gaining access to domestic markets abide by the rules so that investors can have confidence in dealing with them. One of the essential criteria used in Australia to determine whether or not relief will be granted is whether there is effective cooperation between ASIC and the home jurisdiction's regulator. ASIC will not grant relief if this criteria is not satisfied. 33 Effective cooperation arrangements will generally take the form of Memoranda of Understanding, although informal arrangements may also be acceptable. 34 Effective cooperation is to provide for prompt information sharing by the home regulator and communication on supervision, investigations, and enforcement. 35 From an administrative perspective, ASIC has relied heavily on the International Organization of Securities Commissions ( IOSCO ) Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information 36 ( MMoU ) as a strong indication that effective cooperation arrangements are in place. Although the MMoU is focused primarily on cooperation in enforcement rather than supervision and inspections, a securities regulator is only able to sign the MMoU if it has satisfied IOSCO that the jurisdiction has the legislation and procedures in place to provide the investigative assistance contemplated by the MMoU. ASIC has been able to leverage off the thorough assessment process undertaken by IOSCO, whereas with jurisdictions where there is a bilateral memorandum of understanding ( MoU ) in place, ASIC needs to take into account its experiences with that jurisdiction and what limitations apply to the information or assistance that can be provided to ASIC under the MoU. The Blueprint, while recognizing that effective cooperation between the SEC and its foreign counterparts is essential, advocates a much more proactive approach for satisfying this requirement. Substituted compliance would require that as a condition of exemption, a specific bilateral agreement must be entered into between the SEC and the home jurisdiction's regulator. It is contemplated that: [T]he framework process would conclude with negotiation of an enforcement, inspections, and information-sharing technical arrangement or memorandum of understanding that would enable the two partners not only to share enforcement-related information and cooperate with each other's enforcement investigations, but also to share inspections reports, conduct joint inspections, and cooperate with each other at the prudential oversight level. 37 ASIC has not generally required a separate MoU or agreement to be entered into to specifically address the provision of information or assistance for supervision or 33 ASIC, PS 176, supra note 2, ; ASIC, PS 178, supra note 2, ASIC, PS 176, supra note 2, ; ASIC, PS 178, supra note 2, ASIC, PS 176, supra note 2, ; ASIC, PS 178, supra note 2, International Organization of Securities Commissions (May 2002), available at 37 Tafara & Peterson, supra note 1, at 58 (citation omitted).

10 30 Harvard International Law Journal Online / Vol. 48 enforcement purposes in order for the effective cooperation criteria to be satisfied. Instead, existing MoUs have worked well to secure the prompt exchange of information for enforcement purposes. ASIC also has given precedence to effective cooperation in the enforcement context, particularly since monitoring a foreign financial-service provider or FCIS is regarded primarily as a matter for the home regulator. If ASIC has any concerns about the entities compliance with the laws of its home jurisdiction, then those concerns would be referred to the home regulator. However, ASIC would support the development of a bilateral agreement to define cooperation in the areas of inspection and prudential oversight. ASIC's experience is that the vast majority of securities regulators are able to and do share surveillance or inspection information with ASIC even though such assistance is not expressly provided for within the provisions of the MMoU or a bilateral MoU. The advantage of a specific MoU to facilitate substituted compliance would be to formalize what is generally regarded as good regulatory practice. While effective cooperation between regulators is always important, it becomes even more so in circumstances where a system of substituted compliance is introduced. Regardless of the form that cooperation arrangements take, what is essential is that they result in an effective, efficient, and timely response. ASIC and the SEC have a long history of cooperation that we have found to be invaluable in performing our domestic regulatory functions. While information sharing for regulatory purposes occurs daily, joint inspections and joint investigations have been less common, partly because they can be difficult to organize. Yet they can be very useful, as each regulator will bring different information and different skills from which the other can learn. In the case of a joint inspection, there is also an advantage for the entity involved in avoiding the duplication of effort. V. APPLICATION OF ASIC POLICY STATEMENTS As indicated above, PS 176 has been in place since 2003, while ASIC has been administering PS 178 since May Since that time, ASIC has granted relief to 269 foreign entities under PS 176. These foreign financial-service providers, which are domiciled in a range of jurisdictions including the United States, are able to provide financial services to Australian wholesale investors without being granted an AFS licence. In ASIC s view, PS 176 has been effective in achieving its aim of opening up aspects of the Australian market to foreign financial services by reducing regulatory duplication, to the benefit of both the foreign entities and local wholesale investors. However, PS 178 has proven less attractive to FCISs than PS 176 has been to foreign financial-service providers. ASIC has not granted relief to any FCIS since the policy was issued. The number of applications for relief has also been very low A number of entities that were provided relief under the predecessor to PS 178 were grandfathered in when PS 178 came into effect.

11 2007 / Substituted Compliance: An Australian Regulator s Perspective 31 ASIC believes that the reluctance of FCISs to utilise PS 178 is due to structural factors rather than the effort involved in establishing that the home regulatory regime is sufficiently equivalent. VI. CONCLUSION In developing the substituted-compliance model, Mr. Tafara and Mr. Peterson have created a sound and forward-thinking proposal. I welcome this contribution. It represents an opportunity for further discussion between regulators and within international forums about the importance of adapting regulation to enhance the development of international financial markets. The impetus for developing concepts such as substituted compliance is the rapid growth of cross-border securities transactions. Domestic regulation and the assumptions underpinning that regulation are under pressure from the demands of an international marketplace and investors wanting to participate in that marketplace. It is important and increasingly urgent that regulators respond. The strength of any regulatory approach is in a well-founded and well-articulated policy framework. I believe that the approach of developing the broad policy parameters is the correct one. It establishes a clear pathway toward achieving the stated objective of giving greater recognition to foreign regulation in order to reduce the regulatory burden on global financial transactions. It also provides a practical means of meeting the challenges of regulating in a cross-border environment while avoiding the pitfalls of focusing excessively on the details. Endeavouring to reconcile the specific and idiosyncratic rules of various jurisdictions would prove an enormous and quite possibly fruitless task. As the comparison above demonstrates, the ASIC approach and the proposed substituted-compliance model share two fundamental components: the preconditions of a comparable regulatory regime and effective cooperation arrangements. ASIC believes the combination of these two components provides a firm basis for the regulation of cross-border activity. There needs to be considerable flexibility in the application of a policy based on substituted compliance. It remains open to a national regulator in implementing the policy to adopt different approaches to satisfy its own domestic priorities, provided the priorities are aimed at and do actually achieve comparable regulatory outcomes. Mr. Tafara and Mr. Peterson advocate a proactive approach to this analysis in which regulators engage in a dialogue to address possible regulatory gaps. ASIC would be keen to begin this dialogue. Inevitably, any system that provides an accommodation for foreign service providers based on their compliance with similar regulatory requirements in their home jurisdiction will raise concerns about investor protection. It is obviously much easier to prepare and take enforcement action against an entity located within the jurisdiction. However, that itself does not justify an approach that requires duplication of regulation. Whatever approach regulators adopt in response to global developments needs to be sufficiently flexible to respond to emerging trends and pressures as the

12 32 Harvard International Law Journal Online / Vol. 48 international market evolves, while preserving investor confidence in that market. In a global marketplace, investor confidence will not flow from purely domestically focused businesses or regulators. * Greg Tanzer is the Executive Director for Consumer Protection and International Relations at the Australian Securities and Investments Commission. Suggested Citation: Greg Tanzer, Substituted Compliance: An Australian Regulator s Perspective, 48 HARV. INT L L.J. ONLINE 21 (2007),