12 Joffre St
Camberwell VIC 3124

14 December 2012

General Manager
Financial System Division
The Treasury
Langton Crescent
PARKES ACT 2600

Dear Sir or Madam

Submission on “Strengthening APRA’s Crisis Management Powers” Consultation Paper

I refer to the above consultation paper issued in September 2012. 

I am a banking and finance solicitor with a research interest in bank resolution procedures and financial stability issues generally. The purpose of this submission is to set out comments on particular aspects of the legal arrangements proposed in the Consultation Paper.  

Section 1 discusses continuity of service obligations and stay powers in relation to s15C and similar provisions of the Banking Act 1959 (Cth) in comparison with corresponding provisions of U.K. and U.S. legislation. It is desirable that the Australian powers be strengthened in line with overseas provisions identified, in order to ensure that its ADI resolution procedures operated as intended to minimise adverse financial stability impacts and the use of public funding under the Financial Claims Scheme.

Section 2 discusses the consequences for failing ADI’s of recent decisions in relation to derivative transactions governed by ISDA agreements, which limit the rights of a defaulting party to terminate agreements in order to receive payment for in-the-money positions. It is desirable that this position be amended by statute for ADI’s in liquidation to minimise the scope for loss to other claimants on the ADI.

Section 3 provides comments in response to particular areas raised for discussion in the Consultation Paper, while section 4 identifies some other banking regulatory policy issues relevant to the matters raised in the Consultation Paper.

1.	CONTINUITY OBLIGATIONS

Bank resolution procedures often make use of wide powers to override certain contractual restrictions that could delay or prevent implementation of urgent sale or recapitalisation proposals needed to stabilise the bank or prevent contagion to other financial institutions.  While these restrictions represent a diminution of the contractual rights of counterparties, they are generally regarded as necessary in the context of bank resolutions, given the possibility of systemic impacts of bank failures, and the impracticability of obtaining consent from large numbers of bank counterparties.

The Banking Act 1959 (Cth) contains a number of provisions of this type although they may have a more limited application than intended and do not appear to extend to all types of transactions which may be entered into by statutory administrators.

Section 15C(2) provides that the fact that an ADI statutory manager is in control of the ADI’s business does not allow a contract [to which the ADI is a party], or a party to the contract, to do any of the following:

(a)	deny any obligations under that contract;
(b)	accelerate any debt under that contract; or
(c)	close out any transaction relating to that contract.

Scope of protected events should be expanded

This continuity provision does not mandate performance by counterparties of all contracts irrespective of the financial condition or other breaches by the ADI. The events for which the prohibited contractual effects apply are limited to:

s11CD	the issue of a direction by APRA under s 11CA,  s 11CC or s 29;

s13N	the issue of a recapitalisation direction under s 13E;

s14AC	the fact that a statutory manager does an act under s 14AA(1) relating to recapitalisation of the ADI; and

s15C  		the fact that a statutory manager is in control of an ADI’s business. 

If the sale of the ADI’s business takes effect as a voluntary or compulsory transfer of business under the Financial Sector (Business Transfer and Group Restructure) Act 1999 (Cth) s 36AA, restrictions on the exercise of rights under transferred contracts will apply in the same terms as s 15C(2).  Other arrangements for the sale or disposal of the ADI’s business should also be protected, if these are initiated by the statutory manager and need to take effect outside of the compulsory transfer mechanisms.

Insolvency or financial distress in relation to the transferor ADI group should also be excluded. Section 15(C) is too narrowly confined to the appointment of the statutory manager, and leaves open the scope for events of default or potential events of default to arise under finance documents due to the factors leading to the appointment as statutory manager, such as insolvency (inability to pay debts), ratings downgrades, breaches of financial ratios, cross default or the occurrence of a material adverse effect in relation to the ADI and its affiliates. There is no reason to leave open the scope for these events to be exercised in relation to the failing ADI where the statutory manager is to transfer the relevant contract to a new ADI.  

The corresponding U.S. bank resolution provision prevents reliance on such events in qualified financial contracts. 12 USC 1821(e) (10) prohibits the exercise of rights to terminate, liquidate or net a qualified financial contract “solely by reason of or incidental to the appointment of a receiver for the depository institution (or the insolvency or financial condition of the depository institution for which the receiver has been appointed) (I) until 5.00pm on the business day following the date of appointment; or (II) after the person has received notice that the contract has been terminated. The words in italics were included in amendments to the qualified financial contract provisions introduced in 2005 to broaden the restriction on counterparty termination in the context of expansions of netting protection. 

Other jurisdictions do not expressly preclude these factors and provide for a limited exclusion of contractual rights in connection with the statutory transfer. However, it appears this is in order to preserve the operation of the clauses in relation to transferee insolvency or financial standing. There is no express reference to transferor insolvency or financial condition in the corresponding provision in s 22 and 38 of the Banking Act 2009 (UK). However these provisions otherwise have a very broad impact and permit the making of share transfer and property transfer orders in respect of a variety of incidental or related factors, which may include consequential or transitional provisions. It would be preferable for the position to be clarified to prevent creditors pressing for payment outside the terms of the stay on technical grounds, or to require large numbers of technical consents or waivers to be obtained for the transfer to take effect.

Consideration should be given to whether specific transferee events of default should be excluded if these are likely to result from the transfer, e.g. breaches of group exposure limits. In practice major financial counterparties are likely to wish to redocument their facilities to the transferee and provide for incidental changes, however the statutory provisions need to provide an adequate framework to prevent material reductions in the availability and cost of finance to the transferee from existing financiers. Failing to do this will directly reduce the amount which a purchaser will be willing to pay for the assets of the failed ADI. 

Prevention of “denial of obligations” under the contract

Section 15C is likely to be too narrow in its effect. Firstly, the words “do not allow” in the opening paragraph are ambiguous, and do not clearly prevent a term of the contract from having the effects noted.

In relation to s 15C(2)(a), the term “denial” is not a legal term generally used in connection with the exercise of contractual rights and may not be adequate to restrict the wide range of changes to the operation of a contract which may result from a given event.  Also, to refer merely to “obligations” would appear to require the existence of a present unconditional obligation (although the time for performance may or may not have arisen). This may not effectively deal with conditions precedent to performance of an obligation, or other conditional obligations. Virtually all “obligations” imposed on financiers under loan and swap agreements are subject to conditions precedent in this manner, so that no obligation arises unless all conditions precedent, such as the absence of events of default or potential events of default, are satisfied. Examples of wording from market standard finance contracts are provided in Schedule 1 which clearly indicate this. As courts are likely to give a narrow reading to provisions such as 15C which restrict parties’ contractual rights, it is important that they be accurately expressed.

Sections 22 and 38 of the Banking Act 2009 (UK) expressly provide for transfer orders to take effect over both unconditional and conditional obligations, in the definitions of Type 1 and Type 2 default events. Section 22(2) contains a more accurate description of the range of consequences that can arise from events of default under contracts. It also includes the operation of default interest provisions. Section 22(3) specifies the range of conditional obligations.

It is desirable for the Australian provisions to be amended in this manner to ensure these operate as intended. In particular, the current provisions introduce an unfavourable asymmetry in relation to finance and swap contracts between U.K. and Australian banks that could disadvantage Australian banks during systemic crises. This could allow cherry picking of bank derivative portfolios according to jurisdiction, or lead to Australian bank transfers being delayed or hindered by objections raised by foreign counterparties.

Sections 22 and 38 also include desirable flexibility for orders to make exceptions to the operation of these provisions.

The U.K provisions have the potential to apply to third party contracts, although the Code of Practice states this power would be exercised with restraint. The provisions should at least be capable of application to contracts of the NOHC or affiliates, consistent with the group-wide operation of the statutory management provisions.

Exclusion of pre-2008 contracts

The grandfathering of pre-2008 contracts substantially weakens the ability of a statutory manager to make transfers without third party consents. 

While a reticence to interfere with prior contractual rights is usually desirable, the need for effective crisis management powers to deal with financial instability in relation to prudentially regulated financial institutions provides a compelling public interest justification for extending s15C to contracts entered into at any time. Provision of adequate safeguards to continuing suppliers, such the obligation to pay, should ensure that this restriction is reasonable and proportional.

There are statutory and contractual precedents for overriding termination rights of this type to deal with insolvency requirements. Section 440B of the Corporations Act restricts owners of property from exercising re-entry powers where tenants are in administration (although not where they are subject to statutory management). It is common practice in secured bank financing arrangements for lenders to require the borrower to procure that counterparties to material contracts agree to tripartite agreements or step-in deeds which suspend termination rights and allow transfer of contracts provided continuing payment is made by the receiver. These are standard for loans of a few million dollars to property developers and to other small and large businesses. It would be highly unsatisfactory for similar protections to be lacking to support the resolution of systemically important banks with hundreds of billions in assets.

The alternative to removing the exclusion for pre-2008 contracts is to require ADIs to attempt to negotiate agreements in similar terms with key suppliers as part of their resolution plans. This would impose significant legal expenses on ADI’s and re-open for general negotiation settled contracts, without any certainty that satisfactory terms could be agreed. It would require APRA to be a party to each arrangement in order to be legally effective, and impose costs on it. 

The exclusion will also place an administrative burden on ADI’s to monitor excluded contracts and is uncertain in its application where pre-2008 contracts have been renewed or amended.

There is no exemption for pre-amendment contracts from the corresponding provisions in the U.S. or the U.K. Given that nearly 5 years will have elapsed since the introduction of these provisions and their amendment as a result of this Consultation Paper, sufficient notice of these requirements has been provided, and the exclusion should now be removed.

Further consideration should be given as to whether other steps are desirable in relation to foreign law contracts.

External market conditions and conditional facilities

Even with the above changes, the conditional nature of unfunded loan obligations should be borne in mind in considering their adequacy for resolution plans. Many facilities will be either uncommitted or contain conditions allowing suspension of financing by reason of market disruption, breach of law or regulation, or increased prudential costs.  It is desirable for ADI borrowers to attempt to limit these provisions where practical. However, statutory removal of these conditions is inappropriate given that they are necessary protections for international financing.

Stay period

The Government should finalise its position on the proposed changes to the Payment Systems and Netting Act 1998 (Cth) released in 2011, including in relation to the stay period preventing closing out transactions after appointment of a statutory manager. There does not appear to be strong international precedent for extending the stay beyond 48 hours, as proposed in consultations. This was the maximum period supported by the Financial Stability Board given the time critical nature of derivative transactions. The draft EC Proposal and recent Spanish bank resolution provisions are stated in the same terms as the U.S. provisions (suspension ends 5pm the next business day after appointment unless the contract has been transferred). The Banking Act 2009 (UK) is silent on the period of suspension, although it appears regulators will follow the U.S. practice. 

Any short period of this type is insufficient for any analysis of swap transactions, which reiterates the importance of resolution planning and finalisation of sale arrangements before appointment of a statutory manager. Section 44 of the Banking Act 2009 (UK) confers a reverse transfer power which may be used to put back unprofitable sets of derivative contracts if these have been transferred.

Financial market protections

Subject to the inclusion of the temporary stay provision, the U.K. financial market protections should be considered for inclusion in the revised Australian provisions. These are intended to prevent cherry picking by requiring all or none of the financial contracts with a particular counterparty to be transferred, and to protect certain netting security and title transfer arrangements. The U.S. provisions are somewhat broader in requiring transfer of all financial contracts with a counterparty and its affiliates. Affiliate inclusion appears unnecessarily broad if the U.K. protections are adopted, although different rules may be desirable for customer and interbank ISDAs.

Express trust and responsible entity capacities should be taken into account in defining the meaning of “counterparty”. Set-off would not be permitted where there is no mutuality on account of different trusts, and there is no reason to require all contracts with a single trustee of multiple trusts to be transferred together. Separate treatment is also appropriate if the parties have agreed to contractual separation through the use of unrelated ISDA Master Agreements, or have otherwise excluded set-off.

The extent of set-off protection on transfer should also be considered; i.e. whether it should be confined to the operation of the termination closeout provisions, and exclude boilerplate set-off clauses such as in section 6(f) of the ISDA Master Agreement which will apply more widely to unrestricted transferor deposits with the counterparty.

2.	THE APPLICATION OF “WALKAWAY CLAUSES” IN ISDA AGREEMENTS IN RELATION TO FAILING ADI’S

There has been extensive litigation conducted in the U.K. and the U.S. to clarify the rights of non-defaulting parties to ISDA agreements to suspend payments without invoking the net settlement payment obligations that arise on termination. The issue arises where an insolvent or defaulting counterparty has the benefit of “in the money” positions on its swap agreements, and the non-defaulting party (i) attempts to defer its own scheduled payment obligations; and (ii) does not terminate the swap in order to avoid making a termination payment to the insolvent estate.  These rights arise due to the conditional nature of payment obligations in Section 2(a) of the ISDA Master Agreement, set out in Schedule 1.

The position now appears to have been settled in the U.K with the Court of Appeal’s decision in April 2012 on Lomas v Firth and three related cases, which confirmed the rights of non-defaulting parties. The decision confirmed that there are no implied terms under English law which require a non-defaulting party to designate Early Termination on default or after a reasonable period, or which cause its payment obligations to revive on maturity. This aspect of the decision is consistent with the Australian position decided by the NSW Court of Appeal in Enron v TXU. The U.K. Court of Appeal also overruled lower courts on two points relevant to the calculation of the net settlement termination payments which had the potential to bias those payments in favour of non-defaulting parties. The Court held that there were no circumstances in which non-defaulting parties were entitled to gross payments, and that termination values were required to take into account amounts owed to the defaulting party. 

The decision has introduced an inconsistency with the position in relation to banks and other corporations incorporated in the U.S. The decision In re Amcor Funding Corporation encouraged non-defaulters to immediately close-out on liquidation by holding that they could waive their rights to terminate by delay. In Re Lehman Bros. Holdings Inc held that suspension of payments fell outside the safe harbour in 11 USC 365(e) for termination, liquidation and acceleration of qualified financial contacts, and was thus an unenforceable modification or termination of contract in relation to a bankrupt debtor. 

A similar position will apply in relation to U.S. depository institutions under 12 USC 1821(e)(8)(G).This provides that no walkaway clause shall be enforceable in a qualified financial contract of an insured depositary institution in default. It suspends each party’s obligations from the time of appointment of a receiver until the earlier of notice of transfer or 5.00pm on the business day following the day of appointment. “Walkaway clause” is defined broadly to mean any provision that suspends, conditions or extinguishes a payment obligation, or does not create a payment obligation which would otherwise arise, solely because of the party’s status as a non-defaulting party.

The insolvent party’s inability to terminate has the potential to substantially reduce the value of an ADI’s in the money positions if these cannot be transferred to a new ADI. Legal conditionalities relating to the Lehman’s derivative portfolio appear to have played a major part in the value destruction which resulted from its Ch 11 bankruptcy. Senior unsecured creditors are estimated to receive only a 22% recovery from the estate, with subordinated debt and shareholders receiving nothing. It was estimated that liquidation caused a $50bn loss to the estate, despite a pre-liquidation positive net position of $22.2bn. The FDIC has argued that the application of effective stay powers and pre-planning to achieve a successful sale could have avoided this loss.
 
While Australian banks have much lower derivative exposures, significant losses and market impacts from liquidation remain likely. In the event that transfer is not possible, failing to require termination of “in the money” ISDAs will significantly reduce funds available to the estate and incur heavy costs by delaying liquidation.

Australian ADI’s may be placed at a relative disadvantage in relation to ISDA agreements with U.S. banks and companies due to the asymmetrical position under bankruptcy laws despite the superficially consistent treatment of each party under the terms of the ISDA Master Agreement. An Australian ADI would be required to exercise early termination in case of U.S. default, while the U.S. counterparty would not and would be free to suspend its payments in case of Australian default.

The U.K. has for some time foreshadowed legislative changes to deal with this situation if changes to ISDA documents are not forthcoming.  The matter could be dealt with in ISDA documents by including in the Schedule an Additional Termination Event in relation to a party where the other party exercises its rights to suspend payments under Section 2(a)(iii). In addition, ISDA agreements linked to syndicated loans invariably allow the banking syndicate to terminate the swap and claim an in the money payment if the loan is accelerated. 

However, it does not appear that ISDA will recommend mandatory changes to the Master Agreement on this point. ISDA’s arguments in relation to the valuation and gross set-off issues were upheld by the U.K. Court of Appeal. There will be no reason for U.S. members to support changes as their position is protected by legislation. Financial institutions will usually discount the risk of, or need to address, their own insolvency and prefer to strengthen the rights of non-defaulting parties under ISDAs with customers, which are generally of lower credit standing.  Any change that were to occur would only take effect for future agreements entered into. 

Legislation will therefore be needed to assist bank resolution, given that reduction or delay in counterparty payments will directly increase the amount payable under the Financial Claims Scheme or reduce amounts available to other creditors. In principle, the same position should apply in corporate insolvency law. However, given that the Government will not introduce wide insolvency moratorium provisions under the Corporations Act at this time, it may be preferable to confine proposed changes to those necessary for prudentially regulated financial institutions.

Legislating for this change would also improve compliance with ADI prudential standards. Capital treatment of netting agreements is conditioned on the absence of a walkaway clause, reflecting the U.S. position. At the present time this would not be satisfied by an Australian or English law standard ISDA.

3.	BRIEF COMMENTS ON PARTICULAR PROPOSALS

Section 1.1 Broadening the scope for resolution of groups

Option D preferable

The Discussion Paper correctly describes the difficulties of resolution of ADI groups. The ability to appoint a statutory manager to a non-ADI group company will be desirable in some cases in order to ensure that APRA is able to effectively control the activities of the company to facilitate the resolution of the ADI and in particular to allow the statutory manager to transfer title to relevant assets. However, the ability to provide directions as a supplement or alternative may be desirable in some cases, e.g. where appointment of a statutory manager to a foreign subsidiary could breach local licences or is not enforceable. As such, the combination of options described as Option D is preferable. 

Provision of fair value for services provided by non-ADI’s is a necessary protection, although clarity will be needed on who is responsible for paying, and where this obligation ranks in the priority of payment. In a liquidation, ongoing services would usually benefit from first ranking priority as an administrative expense of the liquidation.

Consider impact on group financing

The wide scope for group statutory management and the proposed suspension of clawback has the potential to hinder some forms of financing for the NOHC and non-ADI group members, as their effect is to confer priority rights over a wide class of assets on APRA over the rights of general creditors of the NOHC or other group members. Whether this is a practical obstacle will depend on the particular legal arrangements, capital structures and mix of non-ADI business lines of individual groups. It may have the potential to adversely affect attempts to raise finance in other areas of the group, such as the issue of asset backed securities. 

If Options A or D are to be adopted, a mechanism to clarify the scope of permitted financing activities and to restrict the powers of the statutory manager and APRA in respect of secured assets would be desirable. The protection for covered bond holders in s 31B of the Banking Act 1959 (Cth) provides an example. However, given the diversity of possible financing structures and the need to consider their suitability in the context of the relevant ADI, flexibility should be provided to APRA to agree suitable permissions, which the ADI and investors can rely on. These should be agreed by the ADI with APRA as part of  recovery and resolution planning. Alternatively, if all asset backed securities activities are conducted outside of the defined groups, these precautions may not be needed.

Clarity should also be provided that statutory managers’ powers do not extend to assets held under other regulatory schemes, e.g. members’ interests under superannuation funds and managed investment schemes, life office statutory funds, and capital requirements for ASIC licensees. Potential conflicts between ADI and other regulatory requirements should be considered generally.

Section 2.1 Enhancing APRA’s Direction Powers

These changes are generally desirable. Those proposed in sections 2.1.1 and 2.1.4 are implicit in the current provisions in relation to ADIs. It would not be suitable for APRA to refrain from taking necessary actions in relevant cases prior to these provisions taking effect. Clear statutory mandates were provided in 2008 and 2010 for enhanced prudential supervision powers and early intervention in relation to distressed ADIs in broad terms. 

Section 2.2.2 Removal of State legislative requirements for Business Transfer Act transfers

These references appear to be a carry-over from the referral of State powers under the Financial Institutions Codes for building societies, credit unions and friendly societies. The constitutional basis for transfers of these ADI’s should be considered. I assume this is within Commonwealth power as those organisations are now validly existing under the Corporations Act or other Commonwealth Acts.

Section 3.1.1 Provision for appointment of statutory manager to local branch of foreign bank

The proposal to allow appointment to address Australian financial stability requirements appears reasonable. In the usual case, it would be preferable for liquidators in the head office country to conduct a universal resolution proceeding with Australian creditors sharing on the same basis as international creditors. 
However, as this may not occur in some cases, the ability to conduct a stand-alone resolution is desirable. The fact that the foreign proceeding does not provide for depositor preference (e.g. as in the U.K.) should not necessarily compel or permit Australia to undertake a stand-alone procedure. 

Appointment of a statutory manager may also be a necessary means of assisting a foreign main proceeding given the exclusion of ADIs and life and general insurers from the Cross-Border Insolvency Act 2008 (Cth) and related overseas applications of the UNCITRAL Model Law.

The grounds of appointment should include overseas financial stability requirements where APRA acts to assist foreign regulators.

This is an area where a survey of prudential and resolution approaches to foreign branches in other key jurisdictions may assist. In addition, recovery and resolution planning for each ADI should consider the suitable allocation of Australian and foreign proceedings, and any conflicts arising between the differing regimes.

Section 4.1.1 Broaden grounds to allow early appointment

The changes proposed are implicit in the current provisions in relation to ADIs. Sections 13A(1)(b)(i) and (ii) were introduced in 2008 with the same intention to permit early intervention: “may become unable to meet its obligations” or “may suspend payment” are much wider than an actual or near insolvency.  The provision is already expressed according to APRA’s subjective discretion. The same comment therefore applies as in relation to section 2.1.

Failure to comply with a direction should permit appointment. APRA should consider whether it is desirable to emphasise that actual or threatened breaches of key capital or liquidity ratios in the statute are grounds for appointment. I assume there is no desire to redraft voluminous technical material from prudential standards relevant to Basel capital calculations, although a briefer cross reference may be possible.

I assume from previous amendments that the Government does not wish to adopt an express “Prompt Corrective Action” formula as per the U.S. or similar staged approach to mandate enforcement at pre-determined capital levels. 

The existence of grounds for termination of the ADI’s authorisation under s 9A should also be included. This appears implicit in 13A(1)(b)(iii) and (iv) although the separate procedures may imply different treatment.

Section 4.1.4 Appointment of a statutory manager to a bridge bank

I understand that a bridge bank is intended to act as a clean and solvent purchaser to hold the assets of the failing bank on a transitional basis. It would appear preferable that adequate powers were conferred to fulfil these functions without the need to make it subject to a form of insolvency administration. This could have adverse effects on counterparty confidence and not be effective to cure breaches of foreign contracts, licences or clearing house rules. Overseas precedents for this approach should be identified before proceeding with this option. 

Financial responsibility for ongoing services supplied to the bridge bank should also be clarified.

Section 4.2.1 Moratorium proceedings

Consider making APRA’s refusal to consent to proceedings etc binding, notwithstanding Court permission, particularly where necessary for financial stability requirements. While harmonisation of provisions across a range of regulated financial activities may be desirable, it may be necessary to distinguish financial crisis events with systemic importance from less severe business failures.

An issue for further consideration is whether sufficient constraints have been placed on shareholder claims for continuous disclosure breaches under s563A of the Corporations Act. While these have now been subordinated in liquidation, they may present an obstacle to open bank resolution. 

The risk of such an action against a failing bank is almost inevitable given the constraints on public disclosure of negative credit information. Any assertion of rights by shareholders to recovery of damages on these grounds is inconsistent with the requirement that equity provide an unconditional buffer against default under Basel capital requirements. Class actions in respect of these types of breaches are becoming increasingly difficult to manage given uncertainty as to damages principles, third party funding arrangements and opportunistic investor activity.

Section 4.3.1 Power to manage the ADI’s business not overridden by order of priority

Consider as an alternative whether it is feasible to provide for an administrative expense first priority position. While the statutory manager should have flexibility to meet requirements, there may be scope for inequitable treatment if debts are fully repaid to particular creditors and transfer arrangements avoid the scope for preference recovery.

Consider also whether the relation with liquidation order of priority, including priority expenses, in Part 5.6 Div 6 of the Corporations Act should be clarified. It appears these take effect under s13(A)(3)(f) in the Banking Act behind all preferred claims under the Banking Act.

Section 4.3.2. Statutory immunity

The exclusion of liability for “negligence” is desirable and consistent with the contractual position in private financings. Banks do not allow their financing documents with borrowers to contemplate that the bank could be sued for “negligence” based on its appointment of a receiver. 

A “good faith” proviso may not be sufficient to prevent large speculative claims based on alleged supervisory liability for failing to appoint at an earlier time. It would be desirable to clarify that the depositor protection obligations and prudential regulation powers in the Banking Act are not intended to confer privately enforceable rights or to create financial liabilities other than those provided in the Financial Claims Scheme. Please let me know if a submission on these points discussing overseas provisions is required.

Section 6.1 Mandatory FCS activation where ADI is in liquidation

This change is desirable. A discretion to not activate the FCS for a failed ADI is inconsistent with the public understanding of the scheme as a government guarantee. ASIC has approved promotional materials to assist smaller ADI’s to capitalise on the benefits of the scheme using the term “government guarantee”. This is quite misleading given the current provisions: a guarantee requires an obligation to pay. 

Section 8.6 Enhanced disqualification standards

Consider whether the “fit and proper person” test needs to be supplemented to encompass individuals who may be skilled and well regarded in their own fields and yet unwilling or unable to act in senior roles in a manner consistent with prudential regulatory requirements. Alleged failure to meet a “fit and proper person” test may imply serious behavioural or character shortcomings, which will invite legal challenges and encourage conservatism by courts assessing disqualification applications. An example of an unsuccessful disqualification attempt is where a respectable lawyer was unrepentant as to his failure to encourage due diligence for a failed acquisition by HIH. Civil penalties would not be appropriate for this broader category; the concern is to ensure prompt removal from particular sensitive positions (e.g. where a senior executive of a distressed ADI refuses to raise capital or obstructs sale proposals). Disqualification on this ground should not necessarily require removal from all finance industry positions.

Section 9.5  Financial Sector (Shareholdings) Act and other intra-government approvals

Consider whether an exception should be made to the FSSA and FIRB requirements to facilitate transfers by statutory managers, or whether relevant approval procedures need to be streamlined. A consolidated set of intra-government approvals and consultation requirements (including ASIC and trade practices matters) for such transfers should be identified and inconsistencies considered. Given that statutory management and sale arrangements will be initiated by APRA, ADI’s may be unable to manage all required steps alone and should be able to assume that all relevant government approvals will be forthcoming.

4.	OTHER BANKING POLICY ISSUES

The following banking regulatory policy issues should be considered in conjunction with the development of proposals outlined in the Consultation Paper.

Need to commence resolution planning

The development of suitable statutory  proposals will be hampered if ADIs have not undertaken resolution planning. This should be commenced in conjunction with recovery planning. This is necessary to identify priority areas where regulatory co-ordination, documentary changes or advance planning may be required.

Order of priority applied to assets and liabilities in Australia

The Government should consider the IMF recommendation that the limitation to liabilities in Australia be removed, in light of other proposals in relation to the ADI order of priority and foreign branches.

Bail-in of debt

The Government should advise whether it has any plans in addition to the scope for liquidation of ADIs to impose bail-in requirements on unsecured debt generally, as discussed by the IMF. The Government’s proposals do not include the ability to force conversion of debt to equity to facilitate open bank resolution, or arrangements for CoCo’s or other specific hybrid convertible instruments. Any such proposals to require general conversion of debt to equity should consider the impact on the relative attraction and availability of bank unsecured debt funding given the impacts of depositor preference, covered bonds and asset backed securities.

Application to shadow banking entities

The statutory management procedures are proposed to apply to entities prudentially regulated by APRA and, to a limited extent, their affiliates. Consider whether there should be scope to apply the statutory management regime to shadow banking entities (non-bank lenders, finance companies, securitisation vehicles, money market funds, hedge funds) if necessary for financial stability reasons, either in conjunction with or in the absence of extensions of prudential regulation. The U.S. orderly liquidation provisions and proposed U.K. investment banking rules provide examples. Financing impacts and interactions with existing insolvency regimes would need to be considered.

Please contact me if you would like to discuss any of these comments. I would be pleased to provide further elaboration on particular points identified, although would benefit from a discussion on key directions in light of consultations.

Yours sincerely

Bruce Taylor
btay9125@bigpond.net.au
SCHEDULE 1 – EXAMPLES OF CONDITIONAL OBLIGATIONS IN FINANCING CONTRACTS

Asia Pacific Loan Market Association – Multicurrency revolving facility agreement

1.	Conditions of Utilisation
1.1	Initial conditions precedent 
No Borrower may deliver a Utilisation Request unless the Agent has received all of the documents and other evidence listed in Part I of Schedule 2 (Conditions precedent) in form and substance satisfactory to the Agent [(acting [(in the case of paragraphs [*])] on the instructions of the Lenders)].  The Agent shall notify the Company and the Lenders promptly upon being so satisfied.
1.2	Further conditions precedent
(a)	The Lenders will only be obliged to comply with Clause 5.4 (Lenders' participation) if on the date of the Utilisation Request and on the proposed Utilisation Date:
(i)	[in the case of a Rollover Loan, no Event of Default is continuing or would result from the proposed Loan and, in the case of any other Loan, ]no Default is continuing or would result from the proposed Loan; and
(ii)	the Repeating Representations to be made by each Obligor are in all material respects correct and not misleading.
(b)	The Lenders will only be obliged to comply with Clause 6.3 (Change of currency) if, on the first day of an Interest Period, no Default is continuing or would result from the change of currency and the Repeating Representations to be made by each Obligor are in all material respects correct and not misleading.
["Default" means an Event of Default or any event or circumstance specified in Clause 23 (Events of Default) which would (with the expiry of a grace period, the giving of notice, the making of any determination under the Finance Documents or any combination of any of the foregoing) be an Event of Default.]

ISDA Master Agreement Clause 2(a)

(i) 	Each party will make each payment or delivery specified in each Confirmation to be made by it, subject to the other provisions of this Agreement.

(ii) 	Payments under this Agreement will be made on the due date for value on that date in the place of the account specified in the relevant Confirmation or otherwise pursuant to this Agreement …

(iii)	Each obligation of each party under Section 2(a)(i) is subject to (1) the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing, (2) the condition precedent that no Early Termination Date in respect of the relevant Transaction has occurred or been effectively designated, and (3) each other condition precedent specified in this Agreement to be a condition precedent for the purpose of this Section 2(a)(iii).