Financial Services Update: How Can AFSL Audit Prompt an ASIC Surveillance Visit?

How can an AFSL audit prompt an ASIC surveillance visit?

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In this edition:

  • How can an AFSL audit prompt an ASIC surveillance visit?;
  • Enhanced risk management – back to the drawing board?; and
  • Financial Advisers Register to come in March 2015.

How can an AFSL audit prompt an ASIC surveillance visit?

Although regulators and industry members will always continue to beat the compliance drum, recent regulatory changes may increase the risk of an ASIC visit.

Australian Financial Services Licence (AFSL) holders will be aware that each financial year their AFSL auditor is required to provide ASIC with a limited compliance audit relating to the Licensee’s compliance with their financial obligations. A broader compliance audit is not required under the law, unless ASIC is prompted to initiate a wider audit by, say, an AFSL audit report.

For any AFSL holder who has ever breached their licence obligations, the Corporations Act 2001 (Cth) (the Act) gives licensees the discretion to report to ASIC only those breaches which are considered ‘significant’ or ‘material’, having regard to the criteria in the Act and ASIC Regulatory Guide 78.

Unfortunately, the Act gives AFSL auditors no such discretion to report only those breaches which they consider significant or material. Under s 990K they have to report to ASIC with 7 days any matter they become aware of in carrying out their duties, that:

  • has adversely affected, is adversely affecting or may adversely affect the Licensee’s ability to meet its AFSL obligations;
  • contravenes a condition of the AFSL; or
  • contravenes the licence obligations relating to keeping financial records, producing financial statements and dealing with client monies and client property.

So why is this important?

Let’s say your AFSL auditor reported to ASIC in their annual audit report (form FS71) that you had not complied with one of the financial requirements under your AFSL, such as the new requirements for fund managers with custodial authorisations which came into operation on 1 July 2014, relating to the preparation and board approval of your 12 months’ cash flow projections. Our Blog of 9 July 2014 outlined these financial requirements for wholesale fund managers.Similar requirements came into force for responsible entities at the same time.

Let’s also say that ASIC has received a few similar qualified audit reports and is therefore concerned that a broader group of fund managers may not be meeting their new financial requirements. Prompted by these concerns, ASIC then decides to pay a surveillance visit to some of the fund managers identified by their auditors. This is where the problem arises because you may not have reported a significant or material breach to ASIC or worse still, you may not have even detected the breach. And once ASIC is through the door, there is a high probability their surveillance visit will have a wider compliance scope than just the immediate issue.

As a fund manager what action should I take?

This hypothetical case is a warning that fund managers should not procrastinate. Fund managers with custodial authorisations (and that means all retail and most wholesale fund managers) need to ensure, before the end of the financial year, that they are complying with all of their financial obligations. This includes the new obligations, which commenced on 1 July 2014.

CompliSpace fund manager clients have been provided with updated policies and procedures to deal with these new financial requirements but for any other fund managers, please contact us for assistance.

Enhanced risk management – back to the drawing board?

Responsible entities (REs) are already required to have adequate risk management systems in place, and to ensure that they are meeting this obligation on an ongoing basis, as part of meeting their core obligations under the Act and RG 104. However, those readers who have followed our financial services blogs over the last few years will be familiar with the progress of various ASIC Class Orders and associated Regulatory Guide (Risk Management Systems for Responsible Entities) which have been sitting in ‘final draft’ since around August 2013.

ASIC has now announced that it is making enquiries of a number of REs of registered managed investment schemes regarding their risk management practices which are ‘a proactive response to the increased market volatility in global and domestic markets [and] aims to examine the adequacy of risk management and disclosure practices in the current environment’. ASIC will direct its focus to fixed income funds, exchange-traded funds and other funds that may experience liquidity issues during periods of market volatility.

In the meantime we are left guessing as to the reasons for the possible delay in the release of this Regulatory Guide. This may be related to updated requirements contained within various RGs, including those within RG 166 and RG 133, which have been released over the last few years. These changes have required REs to adopt additional risk control strategies with a particular focus on enhancing financial and custodial controls – areas highlighted by ASIC as posing higher risks to REs during its original consultation on these proposed changes.

It does seem strange that a draft RG can come so close to release and then be delayed for so long. Perhaps industry has spoken and it is a case of ‘back to the drawing board’ with these proposed changes. Either way, we are back into another round of industry consultation but REs should be aware of their existing risk management obligations, including those contained within the Corporations Act.

Financial Advisers Register to come in March 2015

ASIC has announced that a new register of financial advisers will be released on its MoneySmart website on 31 March 2015.

The Federal Government announced details of the register’s content back in October 2014.

Legislative background

An Exposure Draft of the Corporations Amendment (Register of Relevant Providers) Regulation 2014 was released in December 2014 which proposed amendments to the Corporations Regulations 2001 to allow ASIC to establish and maintain the register and for AFSLs to collect and provide information to ASIC concerning financial advisers which operate under their licence. Consultation on the Exposure Draft closed on 17 December 2014.

According to the Treasury Department, the enhanced register will:

  • enable consumers to verify that their adviser is appropriately authorised to provide advice;
  • find out more information about their adviser before receiving financial advice; and
  • give employers greater ability to assess new financial advisers and improve ASIC’s ability to identify and monitor all financial advisers, which will help to remove disreputable participants from the industry over time.

ASIC’s press release states that the formal regulations will be introduced shortly.

Will it work?

The Senate Economics Committee’s Inquiry into ASIC’s performance revealed serious deficiencies in how the regulator responded to and dealt with, information about misconduct inside the financial planning arm of the Commonwealth Bank. Creating a more substantive public register of financial planners is an initiative designed to increase confidence in the industry by requiring AFSLs to disclose more information about themselves and their authorised representatives and representatives, to investors and the public.

However, as noted by an article by the Sydney Morning Herald (SMH), the register will operate on an ‘honesty system with zero oversight.’ That is, there is no independent entity verifying the information which AFSLs are contributing to the register. This creates a risk of inaccurate or false information being recorded and relied upon by those who access it.

So how can consumers rely on the credibility of the planner they are investigating on the register?

According to Financial Planning Association Chief Executive Mark Rantall they certainly can’t assume that the information published on the register is actually true.

The SMH quotes Mr Rantall as saying that ‘consumers must take responsibility for not only checking their planner is on the register but interrogating about the details provided’.

ASIC has since confirmed (according to another SMH article) that it will be able to issue fines for individuals who fail to register or provide false or misleading statements on the register, using section 1308 of the Corporations Act which prohibits such statements.

The maximum fine for individual advisers will be $8500 with a maximum penalty of $42,500 for corporate entities.

The problems with using fines as a deterrence are that

1. their enforcement requires the illegal conduct to be detected in the first place; and

2: in the financial services industry they have, historically, failed to deter.

Realistically, as pointed out by Mr Rantall, by requiring consumers to do their own due diligence on the information included in the register, which may require more time, effort and skill than most people have available, it seems that consumers are back to square one in terms of being the weaker party in the balance of power between the financial services industry and its retail clients. And if the veracity of the information on the register can’t be trusted, how can consumers trust those who are listed on it?

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