Domestic Regulatory Developments (below extract is from page 57 of RBA's Financial Stability Review - Oct 2017)

Council of Financial Regulators

The CFR is a non-statutory body whose role is to contribute to the efficiency and effectiveness of financial regulation and to promote stability of the Australian financial system. The CFR provides the primary mechanism for coordination between financial regulatory agencies, both on ongoing policy matters and in response to financial disruption, such as occurred during the 2008 financial crisis. Its membership comprises the Reserve Bank (which chairs the CFR), APRA, ASIC and the Australian Treasury. It meets quarterly, or more frequently when required.

Over the past year, the CFR met in December, March, June and September, focusing on crisis management and resolution frameworks for banks and FMIs, housing lending, competition, cyber security and distributed ledger technology (DLT). At the June meeting, the CFR convened with a broader group of agencies with an interest in regulation of the financial sector and the CFR will continue to engage with these agencies in the future.

A key role of the CFR is to ensure Australian agencies are jointly prepared for any financial disruption and to coordinate the response in such an event. In this context, CFR agencies have continued work in two important areas that affect agencies’ ability to deal with a distressed bank – crisis management powers and the level and structure of loss-absorbing capacity.

In August, the government released draft legislation for consultation that would enhance APRA’s crisis management powers. The draft legislation would align APRA’s powers more closely with the FSB’s Key Attributes. In particular, the new legislation provides APRA with:

••         clear powers to set requirements for resolution planning and to ensure banks and insurers are better prepared for a crisis (for example, giving APRA the power to direct an entity to take actions to change its organisational structure so as to ensure that critical functions could continue if the firm needed to be resolved)

••         an expanded set of crisis resolution powers that would allow APRA to act decisively to facilitate the orderly resolution of a distressed bank or insurer (such as by enabling APRA to appoint a statutory manager to an authorised holding company and certain subsidiaries where necessary).

(See the UK's Financial Stability Board's 'Key Attributes of Effective Resolution Regimes for Financial Institutions'.)

Development of an FMI crisis management framework is also underway. Drafting of legislation that will grant the relevant resolution authority crisis management powers to resolve a failing domestic FMI is expected to start later this year.

A second important workstream has been Australia’s approach to implementing an appropriate loss-absorbing capacity framework for Australian banks. While none of the Australian banks are G-SIBs bound by the FSB’s TLAC standard, APRA continues to consider options for a loss-absorbing capacity framework, consistent with a government-endorsed recommendation by the Financial System Inquiry. The CFR has supported this work during 2017, discussing possible approaches and considering the implications of those approaches for Australia.

Crisis simulations are an important tool to both test the preparedness of the CFR to manage the failure of a financial institution and to identify areas that require further attention. In March, the CFR undertook an exercise to step through the range of decisions and actions that would need to be taken in the event that a major Australian bank became distressed. This domestically focused exercise was followed by a larger cross-border crisis simulation in September.

The simulation involved all CFR agencies and their New Zealand counterparts under the auspices of the Trans-Tasman Council on Banking Supervision (TTBC).  The TTBC has been working to strengthen the cross-border crisis management framework over a number of years, recognising the need for effective cooperation and coordination on crisis resolution. The September simulation was aimed at testing parts of that framework and identifying further refinements to crisis management arrangements.

Findings from both exercises will be incorporated in the work programs of the CFR and the TTBC in the period ahead.

In addition to crisis management, a key focus of the CFR over the past year has been vulnerabilities related to lending standards in the housing market and household indebtedness.

The CFR has considered developments in the housing market and emerging risks at each of its meetings over the past year. Given concerns about trends in some types of housing lending in early 2017, it discussed the merits of various policy actions. APRA subsequently announced additional measures in March (see ‘Household and Business Finances’ chapter). The CFR continues to assess the effects of those measures and broader developments in housing markets.

The CFR has recently undertaken two competition-related workstreams, both in collaboration with the Australian Competition and Consumer Commission (ACCC).

•• In early 2017, the CFR considered recommendations from the Review of the Four Major Banks conducted by the House of Representatives Standing Committee on Economics, along with other possible measures for improving competition in the banking sector.

•• In September, it published guidance on competition in the settlement of cash equities in Australia, complementing existing guidance on competition in the clearing of cash equities. The policy framework also includes regulatory expectations for conduct in operating cash equity clearing and settlement services. These apply to a market structure in which the ASX remains a monopoly provider of cash equities clearing or settlement services. The CFR and ACCC will work with the government over the coming year to develop and consult on legislative amendments to provide the relevant agencies with the powers necessary to fully implement the framework.

Other areas of focus of the CFR over the past year have been cyber security and DLT (Distributed Ledger Technology). A CFR working group has been exploring the regulatory approach to cyber security by CFR agencies. As part of this effort, the group has been working on a comprehensive stocktake of the cyber risk landscape in the financial sector, drawing on supervisory information and industry liaison, as well as information from cyber-focused bodies and programs such as the Australian Cyber Security Centre and the government’s Cyber Security Strategy. Another working group has been reviewing regulatory gaps that may be relevant to the uptake of DLT and has identified a number of areas where regulation could be updated or clarified in order to promote financial innovation.

Where CFR discussions are relevant to other government agencies, the heads of those agencies are invited to join the meeting or those agencies are consulted. This has included the ACCC attending recent CFR discussions on competition matters. The CFR this year sought to put in place more formal arrangements with other regulators that have an interest in the financial sector. In June, a meeting was held between the CFR agencies, the ACCC, the Australian Taxation Office and the Australian Transaction Reports and Analysis Centre (AUSTRAC). Topics discussed included the activities of the CFR, the work of the Black Economy Taskforce and the Productivity Commission’s inquiry into competition in the financial system. The respective chairmen of the Black Economy Taskforce and the Productivity Commission attended.

Other domestic regulatory developments

A number of other regulatory developments reflect the focus of the main international workstreams discussed earlier in this chapter.

In addition to its announcement on ‘unquestionably strong’ bank capital (discussed further in ‘The Australian Financial System’ chapter), APRA has continued its program of implementing internationally agreed BCBS reforms. In August, it released a discussion paper on the standardised approach for measuring counterparty credit risk. The discussion paper outlines a series of modifications to an earlier version of the framework, made in response to issues raised during consultation. Among other measures, APRA is proposing a simpler methodology for the measurement of counterparty credit risk exposures for authorised deposit-taking institutions (ADIs) with immaterial exposure to such risk.

APRA has also released the final version of its prudential standard on the margining requirements for non-centrally cleared derivatives. Margin is collateral exchanged to reduce both the counterparty credit risk posed by the default of a market participant and the potential contagion stemming from such a default. Under the standard, compliance with the margining requirements of foreign authorities listed in the standard – such as those in the European Union, Japan or United States – will satisfy APRA’s margining requirements in some cases (‘substituted compliance’). Substituted compliance is intended to alleviate the burden of foreign firms having to comply with the rules of multiple jurisdictions.

Another area of focus has been mitigating misconduct risk. CFR agencies continue to monitor and encourage improvements in the culture of banks and other financial institutions.

In particular, over recent years, APRA has heightened its supervisory focus on culture for all regulated entities. For ADIs as well as general and life insurers, this has emphasised the need for their boards to identify desired changes to risk culture and ensure steps are taken to address those changes. The importance of enhancing culture was highlighted by apparent deficiencies in anti-money laundering practices at the Commonwealth Bank of Australia that were recently revealed by AUSTRAC (discussed further in ‘The Australian Financial System’ chapter).

As noted above, global bodies have increased their focus on fintech (including DLT), and assessing its possible implications for financial stability. A key theme of these efforts is to balance the facilitation of fintech, given its potential benefits, with effectively managing any risks it poses. There have been a number of developments domestically regarding fintech:

•• In the May federal budget, the government announced several new measures to facilitate the development of the fintech sector, such as reducing barriers for new entrants into the banking sector (see below). The government also stated that it would legislate an enhanced ‘regulatory sandbox’. This will build on an existing licensing exemption by ASIC, allowing eligible fintech businesses to test certain services on a limited scale without an Australian financial services or credit licence. Firms operating under the sandbox arrangements remain subject to consumer protection and disclosure requirements.

•• In August, APRA proposed revisions to its licensing framework for ADIs. Consistent with government policies noted above, these revisions aim to increase competition and innovation in the banking sector, by making it easier for new entrants (including fintech firms) to navigate the ADI licensing process.

APRA’s proposals would introduce a phased approach to ADI authorisation and would allow eligible firms to obtain a ‘Restricted ADI’ licence, so that they can begin limited operations without yet fully meeting APRA’s prudential standards. The Restricted ADI licence would be granted for up to two years. So as not to compromise financial stability, APRA expects these ADIs to conduct banking business on only a small scale during this time, with explicit limits applying to deposits covered by the Financial Claims Scheme. Within the two years, the ADI would be expected to build up the capabilities and resources to fully meet prudential requirements and progress to a full ADI licence, or to exit the banking industry in an orderly manner.