Introduction

The Australian financial sector is responsible for managing assets of almost $2 trillion. It is regulated primarily by the Australian Securities and Investments Commission (ASIC). ASIC is responsible for regulating company and financial services laws to protect consumers, investors and creditors. From 11 March 2002, its responsibilities include the licensing of entities engaged in the business of providing financial services, broadly defined.

This responsibility was conferred by the Financial Services Reform Act 2001 (the FSR Act). It amended the Corporations Act 2000 (the Corporations Act) to replace a number of existing financial sector licences with a single licence. Potentially, the new licence extended to a range of financial activities not covered by earlier Corporations Act licences, particularly in the superannuation, insurance, deposit-taking, payment service and foreign exchange sectors.

The primary objectives of the reforms were to benefit the industry through more uniform regulation and to give consumers a more consistent framework of consumer protection in which to make their financial decisions. To achieve these, ASIC received Budget funding of $63 million over the years 2001–02 to 2005–06. This included funds for licensing and for granting relief from licensing, for surveillance and enforcement, and for the development of industry guidance.

Audit approach

The audit objective was to examine the effectiveness and efficiency of ASIC's implementation of Australian financial services licences. In particular, the audit examined ASIC's planning for the introduction of financial services licences; the roles of the Department of the Treasury (Treasury) and ASIC in defining the effective scope of licensing; ASIC's assessment and processing of licence applications; and ASIC's supervision of licensees.

Overall audit conclusions

A single licence regime is now in place for the financial services sector. By the transition deadline of 10 March 2004, ASIC had issued 3 738 financial services licences. By 30 June 2004, this had risen to 3 853 financial services licences. The number of licences had risen to 4 135 by 30 June 2005.

The broad definitions underpinning the Corporations Act licence regime could bring many entities offering financial services within its regulatory scope, either as licensees or authorised representatives¹. However, statutory exemptions have served to limit the scope of the licensing regime, as have ASIC's statutory powers to grant relief from financial services licensing requirements. Together, these have reduced the need for licences.

Two-thirds of all the licences granted during the two year transition period were granted during the last six months. ASIC successfully dealt with the late influx, and the generally poor standard of applications, by reallocating resources from other activities, such as the surveillance of licensees (so that surveillance staff could be available to achieve licensing targets), and by curtailing analysts' scrutiny of applications (to reduce processing time). ASIC's licence systems did not properly record critical elements of its licence decisions, such as ASIC's assessment of the applicant's character or its assessment of the applicant's evidence that they could meet their licence obligations. Overall, important regulatory risks were not systematically addressed until after the end of the transition period.

The end of the transition period has seen ASIC re-structure its licensing activities. From March 2005, licensing operations are carried out within ASIC's Regulation Directorate and licensee surveillance activity within its Compliance Directorate. This better reflects the complexity of ASIC's enforcement and regulatory tasks and the need to have a strong enforcement and regulatory presence in all the areas of the financial services industry. To this end, ASIC is making greater use of risk analysis.

Recommendations and entity responses

ANAO has made seven recommendations, six to ASIC alone. Of these, three are aimed at improving the documentation of ASIC's licence processing, the useability of its public licensee database and the reporting of ASIC's compliance performance. The remainder focus on improving ASIC's processes for identifying and managing regulatory risks.

Treasury and ASIC are the joint respondents to the remaining recommendation, that they consider the benefits of making licence applicants' certifications more enforceable than at present.

ASIC and Treasury agreed with the relevant recommendations. In addition, ASIC provided the following summary comment on the report:

ASIC welcomes the recognition by the ANAO of the substantial and important work done by the organisation to implement the new financial services regime. The transition to that regime represented a very significant change in regulation, and a major challenge, for numerous sectors of the financial services industry.

We agree with the recommendations made by the ANAO, and confirm that those recommendations that relate to ASIC have been or are being implemented.

As the ANAO notes, ASIC has now re-structured its activities. We believe these changes and the resultant changes in the allocation of our resources has positioned us well to deal with the regulatory landscape as the FSR regime matures.

Key findings

ASIC Resources and Budget Funding

The 2002–03 Budget included $90.7 million for implementing financial services reform, including $59.9 million for financial services licensing. ASIC spent more on financial services reform-related activity than was budgeted. In addition, to address the peak licensing workload and the generally poor quality of the majority of the license applications, resources in other units were reallocated to the licensing area. This meant that less resources than were originally budgeted were spent on activities such as surveillance.

Licensing

The Financial Services Reform Consequential Provisions Act 2001 (the FSRCP Act) set out how ASIC was to go about licensing existing industry participants. For two years up until 11 March 2004, those who met basic legislative criteria could directly replace their old licence with a new licence, a process called streamlining. Unlike streamlined applicants, new applicants were subject to the full licensing processes set out in the amended Corporations Act. Over the transition period, ASIC granted 953 licences after a full assessment process, granted another 909 licences under a limited licence assessment process, and streamlined 1 875 old licences into new licences.

ASIC succeeded despite a late rush of applications. To do so, ASIC took administrative action to reduce processing times, accelerated the processes for checking applicants' bona fides, and reallocated resources from other activities (including the surveillance of licensees).

In September 2005, ASIC advised ANAO that considerable additional workload was generated by the generally poor quality of the majority of the licence applications. As a result, the ANAO found that ASIC applied almost twice the resources anticipated on processing licence applications. This was funded, in part, by reallocating resources from ASIC's non licensing activities.

Applications for relief

ASIC has statutory powers to grant relief from financial services licensing requirements. Between October 2003 and April 2005, ASIC granted 2 532 relief applications, half relating to the licensing provisions. ANAO examined ASIC's records of its significant relief applications and confirmed that the applications received a high level of scrutiny.

ANAO estimates that ASIC's processing of relief applications consumed four times the resources initially anticipated. In this context, ASIC advised ANAO in September 2005 that, while it significantly over-estimated the number of relief applications, it also significantly under-estimated the complexity of the applications for relief that were sought.

Licence coverage

Initially, the licensed population under the new financial services regime was less than that of the pre-FSR Corporations Act regime it replaced. Legislative provisions exempt significant proportions of the financial services sector from the requirement to hold a licence. ASIC and Treasury are also of the view that, in light of the rigorous licence assessment process, a significant proportion of former financial service providers who were previously expected to apply for a licence instead chose to act as the authorised representative of another licensee.

ASIC is aware of lower than expected coverage among financial advisers and in the superannuation sector. However, in this respect ASIC advised ANAO, in September 2005, that it was difficult to provide useful estimates of the potential population which might fall within the financial services licensing regime, and therefore of the current rates of coverage.

Licence processes

ASIC's decision to grant a licence depends on its assessment of the adequacy of the facts of the licence application and ASIC's judgment as to whether the applicant complies with the statutory criteria. The main licence assessment record is an electronic Licence Assessment Worksheet (LAW). Developed as a tool to manage licensing work flows, each LAW follows a standard format. It summarises the licence assessment undertaken by ASIC staff and records any comments or concerns they may have raised.

ANAO examined a random sample of 50 LAWs and found that, while effective as a means of managing workflow, they were less effective as a record of licensing decisions. In particular, ANAO found that the LAWs did not always record ASIC's assessment of the merits of the application and its consideration of all relevant matters. Consequently, the critical elements of ASIC's licence decision were not always clearly identified, in accordance with the key principles of administrative law.

In applying for a licence, applicants are required to make certain certifications. ANAO found that there is merit in Treasury and ASIC considering the benefits of making these certifications more readily enforceable.

Consumer information

ASIC's on-line databases are intended to support consumers to make informed financial decisions, through a public register of licensees and their authorised representatives. ANAO detected some deficiencies in the operation of ASIC's internet interface to the databases, which ASIC has since rectified. ANAO has also recommended further improvements to the database to assist members of the public searching on-line for licensee information.

Managing regulatory risk

ASIC aims to prevent, deter and detect non-compliance and, where it finds non-compliance, to rectify it. ASIC's deterrence strategies include the public announcement of surveillance activities and campaigns and their results, including enforcement outcomes.

ASIC's plans for implementing the new licences focused particularly on the risk that many market participants might apply too late to obtain a licence during the transition period. This was borne out by the late rush of applications.

ASIC did not undertake a broad risk assessment of regulatory risks posed by the licensing changes until March 2004. At that time, it gave its highest rating to the risk of unlicensed trading, allocating it a probability of between 70 to 90 per cent and a critical impact. In this respect, ASIC stated in its Annual Report 2003–04 that it viewed the coming years as an opportunity increase resources devoted to compliance and to lift standards of compliance across the industry.

ASIC advised ANAO in September 2005 that it now has in place an integrated risk assessment model that considers both regulatory risk and impact. In this regard, ANAO has recommended that ASIC now undertake a systematic assessment of the regulatory risks posed by financial services licensing.

Monitoring and early warning systems

ANAO found that ASIC has in place a basic suite of regulatory compliance monitoring and early warning systems. These include systems to risk-rate financial sector entities, to record consumer complaints, to monitor the late lodgement of annual financial statements, and record reported breaches of the Corporations Act.

In respect of late lodgement of annual returns, ASIC has experienced a rising rate of default. However, it advised ANAO that it has taken action to reduce the rate of non-lodgement from over 15 per cent to four percent at September 2005.

Over the period 2002–03 to 2004–05, ASIC received 806 statutory notifications of Corporations Act breaches from licensees or their auditors. In most cases, ASIC confirmed that the licensee had rectified the breach and the great majority of breach notifications (95.5 per cent) concluded with no further action. However, a small proportion required more serious attention and enforcement action. While licensees are required to report only significant breaches, this term is not defined in the Corporations Act and licensees may be erring on the side of caution.

ANAO has recommended that ASIC integrate the existing elements of its monitoring and early warning systems to assist in better targeting its surveillance activities.

Surveillance activities

Surveillance is ASIC's key activity for detecting non-compliance. Surveillance helps to ensure that industry participants are meeting their obligations under the Corporations Act and that accurate information has been provided in licence applications. ASIC sought additional Budget funding to conduct surveillance of licensees and to investigate an increasing number of suspected breaches of the law. An additional $25.908 million in surveillance funding was approved for the years 2002–03 to 2005–06, sufficient to conduct almost 4 000 inspections over that period.

ASIC has been unable to reach its surveillance targets due, in part, to the low initial take-up of financial services licences. ASIC's records show 1 596 surveillances of financial services licensees since mid-2002 (when the first licences were issued) until June 2005, representing 54 per cent of its target to that date. The late transition of existing licensees significantly curtailed surveillance, reducing the population subject to surveillance and diverting surveillance resources to licence processing. In December 2005, ASIC advised ANAO that it expects to undertake approximately 1 200 surveillance activities in relation to financial services licensees in the 2005–06 financial year.

Surveillance outcomes

ANAO examined ASIC's electronic surveillance records and found that half of all surveillances resulted in a categorisation of ‘No Further Action' (NFA). However, this categorisation does not adequately reflect the results of the surveillance activities. In particular, surveillance action did occur in some instances categorised as NFA. In July 2005, ASIC advised ANAO it was considering reviewing its recording of surveillance outcomes to determine those which do not properly reflect the surveillance undertaken and to determine more appropriate outcome codes for licence surveillances.

In terms of surveillance results up to June 2005, ANAO found that:

• ASIC's program of verification visits to streamlined licence holders resulted in a significant number of enforcement referrals or requirements for corrective action by licensees. Some 352 licensees were visited to ensure that their documented processes matched those required by their licence applications. More than 7 per cent of those visited were referred for possible enforcement action. Almost half needed to rectify their systems;
• ASIC's examination of businesses' Product Disclosure Statements results in significant changes in almost a third of the cases; and
• a quarter of all surveillances prompted by consumer complaints result in businesses making significant changes to their practices. In addition, these complaint-driven surveillance actions resulted in ASIC considering enforcement action in 13 per cent of cases.

In addition, ASIC also undertakes targeted or campaign surveillance actions. These may focus on particular industry sectors, activities or risks. Of these, 7 per cent resulted in the consideration of enforcement actions and 14 per cent achieved a rectification of the licensee's procedures. However, some 65 percent are categorised NFA and recent ASIC campaigns have resulted in lower than expected enforcement outcomes. In light of this, ANAO has recommended that ASIC review its targeting methodology.

Reporting surveillance performance

ANAO also examined ASIC's public reporting of its surveillance outcomes. ASIC has previously expressed its intent to measure its effectiveness against its statutory mandate and its published strategic plan. In this context, ANAO notes that, in some years, ASIC's Annual Reports have included summary outcomes for particular surveillance activities. However, ASIC's reporting has yet to provide a consistent picture of its surveillance activities and outcomes across its licensed population. ANAO found that there is still progress to be made to relate ASIC's surveillance results to its specified outcomes and objectives, as well as the resources allocated to those outcomes and objectives.

Footnotes

1 At May 2004, 1 083 financial services licensees (or 28 per cent) had appointed 36 367 authorised representatives to provide financial services on their behalf.