The insurance market is hardening which means customers can’t always find traditional insurance solutions for their risk. This has increased demand for
insurance alternatives with greater flexibility and a wider range of solutions for ‘hard to place risks’.
This is the first in a four part series of blogs exploring alternatives such as parametric products, aggregate deductible schemes and discretionary mutuals.

Insurance Alternatives
There are several reasons why the time is ripe for insurance alternatives:

There are more catastrophic events unfolding every year, such as the 2019 Townsville floods. Each time a natural disaster occurs, attention focusses
on the insurance industry’s conduct in the aftermath, for example claims that are not properly assessed and claims that are not promptly paid.
Insurers are leaving certain industry segments and classes of insurance, meaning insureds cannot always find traditional insurance solutions for their
risk.
Technology (including data collection and insurtech) is becoming more effective and prevalent.
Insureds have become more aware of what works for them and what doesn’t, and have a need for a greater range of risk solutions and more flexibility.

Traditional insurance may not be appropriate for every risk, and the market has opened up for more niche or tailored insurance solutions.

Insurance alternatives include parametric insurance, aggregate deductible funds (ADFs), discretionary mutuals and captives. These and other insurance alternatives
can easily operate side by side with traditional insurance. For example, an alternative risk transfer solution can be used to target specific or niche
risk areas while traditional insurance covers broader risks without significantly increasing the cost to the insured.

Who are insurance alternatives suitable for?
We will cover who is the target market for each insurance alternative in our later blogs in this series, but generally, alternative risk transfer solutions
are worth considering if you’re facing a gap in the traditional insurance market, particularly if the problem is:

Cost of insurance;

Convenience of insurance; or

Covering a hard-to-place risk because you can’t find an insurer who has the interest, capacity or appetite to underwrite your risk.

You may also find that insurance alternatives suit you if you’re a buying group or association with stakeholders who have similar interests. In particular,
if you want more oversight and control of your risk exposure and protection, alternative risk management initiatives may support your stakeholders
by driving down the cost of their insurance.

Insurance alternatives are not always insurance
It’s important to understand that insurance alternatives like parametric risk products and aggregate deductible funds are not always insurance for legal
purposes. For example, they may be structured as derivatives, insurance-linked securities (ILS) or a miscellaneous risk product. This means that they
require a different financial product authorisation and may only be offered if you have an Australian Financial Services Licence (AFSL) with a ‘miscellaneous
financial risk’ product authorisation.

This is particularly important if you’re an insured who is looking to purchase through a broker. You want to make sure that whoever is advising you has
the right authorisation and licence to advise on and provide the product.

If you’re an insurance broker, it’s important to be aware of these ‘out-of-the-box’ solutions and know whether, when and how you can advise on these solutions.

If you’re not sure whether you can offer certain alternative risk transfer products or need some assistance in varying your AFSL authorisations, get in touch – we’d be happy to help.

Lydia Carstensen
October 2019

The Safe Harbour provision was supposed to provide financial advisers with more certainty in meeting their legal obligation to act in the best interests of their clients. But in the aftermath of the Hayne Royal Commission, the Safe Harbour provision’s days may be numbered.

What is the Safe Harbour?

More importantly, what isn’t the Safe Harbour? I’ll tell you – it’s not the same as the best interests duty (BID).
The BID is a broad obligation imposed on financial advisers to act in the best interests of their clients. The Safe Harbour provision is just one way to
comply with the BID.
That’s right – the Safe Harbour is merely an option that advisers and licensees have available to them. It’s not compulsory for advisers to comply
with the Safe Harbour provision. However, it is clearly the most common way for advisers to comply with the BID.
To obtain the protection of the Safe Harbour, an adviser must demonstrate that they completed seven steps throughout the advice process. The seven steps
are:

Identify the client’s needs and objectives;
Identify the subject matter of advice sought by the client;
Make reasonable enquires to obtain complete and accurate information;
Assess whether the adviser has the expertise to provide the advice;
Research products that might meet the needs and objectives of the client;
Base all judgements on the client’s needs and objectives; and
Take any other step that would reasonably be regarded as being in the best interests of the client.

ASIC treats the Safe Harbour as the only way to comply with the BID

While the Safe Harbour is the most common way for advisers to comply with the BID, failure to comply with the seven steps does not mean you have failed
to meet the BID. It just means you don’t have the protection of the Safe Harbour. The problem is that ASIC has often treated the Safe Harbour as if
it’s the only way to comply with the BID.
A number of reports issued by ASIC – including Report 515 and
Report 562 – were produced on the basis that if the
client file did not demonstrate compliance with all seven steps of the Safe Harbour provision, then the adviser had failed to comply with the BID.
This isn’t legally correct.
Why has ASIC taken this approach? Because it’s convenient and consistent. It’s easier for ASIC (or a licensee for that matter) to use an objective test
when reviewing client files rather than a subjective one. This is why most licensees have set up their compliance systems to monitor and enforce compliance
with the Safe Harbour, not the BID.
What can go wrong with the Safe Harbour?

In my experience, if an adviser/licensee chooses to rely on the Safe Harbour provision in order to demonstrate compliance with the BID, there are three
main areas where advisers get it wrong:

Failure to demonstrate adequate product research (in particular the client’s existing product);
Inadequate documentation and/or explanation of why the advice is in the client’s best interests; and
Failure to link each recommendation to the stated needs and objectives of the client (i.e. advice looks generic and product-centric, rather than client-centric).

These three areas of failure tie into the obligation to provide advice that is appropriate for the client, taking into account their needs, objective and
circumstances. At a minimum, you must explain how your advice addresses the client’s needs and objectives and why it’s likely to leave the client in
a better position. This should be documented on the client files and summarised in the SOA.
Where to for the Safe Harbour provision?

It’s clear that Commissioner Ken Hayne is not a fan of the Safe Harbour provision. In his final report, Hayne recommended that the Safe Harbour provision
should be repealed at the end of 2022 “unless there is a clear justification for retaining it”. He suggested that the Safe Harbour encourages a form-over-substance
approach to advice. According to Hayne, by removing the Safe Harbour and relying on the BID alone, advisers would have to focus on the quality of their
advice rather than a compliance checklist.
Somewhat bizarrely, it appears that the Safe Harbour provision will not provide much protection with respect to compliance with FASEA Code of Ethics Standard
2. The Explanatory Statement says that “even if you follow the steps set out in section 961B of the Act, you may still not have complied with the duty
under the Code to act in the client’s best interests.”
So while the Safe Harbour provision was designed to provide advisers with a degree of certainty with respect to the BID, we don’t believe it provides as
much protection as many advisers and licensees think. Our view is that using a Safe Harbour “checklist” alone is probably not enough – it really should
be combined with an assessment of the appropriateness of the advice provided.
For the moment, the Safe Harbour provision lives to fight another day, but it may not be with us much longer. If you’re reviewing how your business complies
with the BID or Code of Ethics, get in touch – we’d be happy to help.

Simon Carrodus

September 2019

We’ve recently noticed that both buyers and sellers have heightened concerns about their risks and exposures when transferring financial advice portfolios. Both are looking for different ways to manage their financial risk of recovery. Sellers want to know what their liabilities and obligations to the buyer are and when they will end. While buyers want certainty about what they can make a claim for and whether the seller has the financial resources to meet their indemnity and warranty liability.

Following on from my recent post on warranties and indemnities in the sale of financial advice portfolios, in this post I outline five ways that the financial risk of recovery can
be managed in these transactions.
1.Professional Indemnity (PI) Insurance

It’s standard for a seller to be required to hold PI insurance in sale agreements for financial advice portfolios. But for PI insurance to be effective
in mitigating risk, the buyer must have confidence that it will cover the seller’s exposure for a period of time after the sale. Without this, the
indemnities are worthless because there is essentially no safety net if the seller can’t fund the payment of a claim. The PI insurance run-off period
is a critical element of this.
Traditionally, sale agreements have required PI insurance to be current at completion and maintained in run-off for a minimum of 6 years. But following
the Hayne Royal Commission we’ve seen a hardening in the PI insurance market for the financial services industry. This has made it difficult for most
sellers to obtain PI run-off insurance for more than 3 years.
PI Insurance also may not cover the seller if they haven’t complied with community standards or practices, or if they’ve breached the law. For example,
if they charged clients for services that were never provided. The government has also recently extended its reach to consider eligible financial disputes
dating back to 1 January 2008.
These issues are making it difficult to determine what is an acceptable PI insurance run-off period. So I’ve had to identify other creative ways to help
buyers limit their exposure and mitigate their risk of financial recovery.
2.Warranty and Indemnity (W&I) Insurance 

W&I insurance is often used to cover the buyer for financial loss when the seller breaches the specific warranties and representations they gave in
the sale agreement. This is often referred to as a buy-side policy.
In a buy-side policy, the buyer may recover directly from the insurer for any loss suffered. This mitigates their risk that the seller won’t be around
or have sufficient funds to cover a claim. This makes W&I insurance a useful tool to bridge the divide between the seller’s need to limit their
liability and the buyer’s need for comprehensive warranties and indemnities that they know they can recover financially.
W&I insurance isn’t a new concept but it’s been gaining favour in Australia recently and I don’t see this changing. But it isn’t easy to obtain and
can be expensive. Whether it’s suitable for your transaction will come down to a number of factors including:

Deal value: The cost of the insurance may exceed the amount you’re insured for
Your commercial drivers: It’s often looked to when there are multiple sellers or the seller wants a ‘clean’ exit
Other available options to reduce the financial risk of recovery
Whether the parties are willing to do a deep dive due diligence: Insurers will require this before providing a W&I policy

3.Escrowed funds

Holding a portion of the purchase price in escrow is a relatively simple way for the buyer to know that there will be funds available to meet any warranty
and indemnity claims. Obviously the level of comfort depends on the amount held on escrow and how long it will be held there.
When negotiating an escrow fund, parties need to agree:

Who controls the escrow account
The amount to be held on escrow
How long the funds will remain in escrow
When the funds can be paid out
Who the funds can be paid out to
When unused funds can be released to the seller

All these details can be covered in the sale agreement.
If the deal is complex or high value, you could use an escrow agent. You may also need to put in place more complex documentation to regulate the arrangements.
For smaller deals, the escrow account could be jointly directed by the buyer and seller, or at the sole direction of the buyer.
4.Payment by instalment

When you pay by instalments, the buyer essentially defers payment. This reduces their upfront payment and increases their subsequent payment(s). Paying
instalments over a period of time is a well accepted practice in the financial planning book buy/sell space.
Current deals I’m seeing are pushing these out to 60% upfront with the balance paid over 12 to 24 months. This is usually on a 20%/20% basis. In the past,
the norm was a 70/30 split over 12 months. The current trend keeps the seller at risk for longer and gives the buyer a longer period and larger amount
to claim back.
I’m also seeing new and extended clawbacks and adjustments. These are being added to the traditional ‘rise and fall’ protections. This is being achieved
with bespoke provisions that cover specific risks including:

Remediation costs
Extension to breach of warranty claims
Changes in the law affecting remuneration, including fees for no or limited services and possible changes to life insurance commissions

The challenges faced by sellers are compounded by buyers expecting to pay lower multiples. Transactions are currently trending at the 2 to 2.3 x multiple.
Fixed purchase prices are also gaining favour.
5.Personal guarantees

As noted in my last post, buyers are now also asking sellers to give personal (owner/director) guarantees. But these are only worthwhile if the buyer does
due diligence on the guarantors and their financial position to make sure they can pay a claim.
If you’re negotiating or preparing to sign a portfolio transfer agreement, you should seek legal advice to make sure you’re mitigating your risk and exposure
under the agreement. If you would like any other information on tricks and traps for undertaking divestments, mergers and acquisitions, please get in touch.
We’d be happy to help.

Katie Johnston

September 2019

New whistleblower protections expand who is protected and what they can disclose. This regime applies to regulated companies and financial service providers including banks, life companies, general insurers and superannuation funds. 

More people are now protected whistleblowers

The new regime came into force on 1 July 2019 and creates the concept of an ‘eligible whistleblower’. This expands who can make a protected disclosure.

Under the old regime, just your current employees, officers and contractors were protected. Now protected disclosures can be made by your current and former:

Employees;
Officers;
Contractors or suppliers (whether they were paid or not);
Employees of contactors or suppliers; and
Even a spouse or relative of any of the above. Yes, you read that correctly.

If a person qualifies as an eligible whistleblower, their motivation for making a protected disclosure isn’t relevant. An eligible whistleblower just needs
to meet the requirements for the type of disclosure they are making.

More types of disclosures can be made

The type of disclosures that can be made by whistleblowers has been expanded to include:

Ordinary disclosure: Where the whistleblower has reasonable grounds to suspect the information concerns misconduct or an improper
state of affairs or circumstances about the organisation or a related company;
Public interest disclosure: Where the whistleblower believes it’s in the public interest to tell the press or a member of parliament.
They can do this if they have reasonable grounds to believe that no action has been taken to address the issues in an ordinary disclosure within
90 days; and
Emergency disclosure: If the whistleblower has reasonable grounds to believe that the information concerns a substantial and imminent
danger to the health or safety of someone or to the natural environment.

Protected disclosures can be made to a wide range of people

Protected disclosures can now be made to:

ASIC, APRA, and other prescribed Commonwealth authorities;
Officers or senior managers of the organisation or related companies;
Auditors or actuaries of the organisation or related companies; or
People authorised by the organisation to receive disclosures. This may include a hotline or a lawyer in certain circumstances.

There are more protections for whistleblowers

Whistleblowers also have more protections including:

Anonymity;
Immunity against being prosecuted; and
Any detriment caused by victimisation.

Anyone who breaches these protections may face substantial civil or criminal penalties.

If you’re a public or large proprietary company, you’ll need to develop and implement a whistleblower policy by 1 January 2020. ASIC is currently getting
feedback on its draft Consultation Paper CP 321 which provides guidance for whistleblower policies.

If you haven’t done so already, you’ll also need to think about what changes you need to make to your governance, risk and compliance framework for this
new whistleblower regime. If you’d like to know more about what you need to have in place, get in touch.
We’d be happy to help.

Michele Levine and Michael Sim

September 2019

The rise of cryptocurrency has created new challenges for everyone from crypto token designers through to brokers and custodial service providers. The biggest issue is how to characterise a token and whether it’s a financial product.

While ASIC has issued some helpful guidance on what a crypto token is, it’s really only useful for someone who is designing their own token from scratch. For anyone involved in listing tokens
or providing a liquid market for them like exchanges, brokers or custodial service providers, ASIC’s guidelines don’t necessarily help determine the
character of a specific token already in existence or how it’s regulated.
Common financial products applicable to tokens

When looking at whether a token is a regulated financial or credit product, we often have to undergo complex regulatory analysis. This is because crypto
tokens can run the full gamut of regulated financial products, but they’re typically one of the following:

A payment system
A derivative (of which there are multiple kinds, some are exempt and some are not)
A debenture (only some of these are not regulated)
A share
A managed investment scheme
An insurance product
A consumer credit product
Although less common, a crypto token could also be:

An interest in a superannuation fund
A banking product
A foreign exchange contract
A purchased payment facility
A miscellaneous risk facility

Each of these products are regulated in a particular way and have their own specific legal requirements. While you may describe a crypto token in one way,
like a currency for example, under the law it may actually be something completely different.
Everyone in the chain needs to know what financial product they’re dealing with

Anyone who facilitates the liquidity of a crypto token needs to understand how the token is regulated. If your company is doing this for multiple tokens
it can become a very expensive and time consuming exercise.
A self-assessment tool, like a flowchart can help you analyse what type of token you’re dealing with. This may break down each aspect of the token into
its many components so you can self-assess rather than needing to get legal advice for every token. It can’t identify every token, but can help you
easily identify simple, unregulated tokens, such as tokens which are solely a store of value.
Defining crypto tokens is a global issue

The issue of how to define a crypto token is not limited to Australia. With blockchain now facilitating the growth of these instruments across borders,
there’s clearly a need for a consistent approach to global regulation.
The OECD has recently called for global regulators
to work together to provide clarity and create a supervisory framework for initial coin offerings (ICOs). While the International Organisation of Securities
Commission (IOSCO) has taken this on board, so far they seem to only be collecting a repository of the regulatory regimes in different countries.
What this does highlight is just how expensive it is for organisations who trade tokens across borders to meet each jurisdiction’s regulatory structure
– just imagine multiplying the cost of navigating Australia’s complex regime in multiple countries.
This failure to find a global solution for the regulation of crypto tokens will hold up the development of this product. In the meantime though, we have
to contend with the regulatory regime that we have.
So, if you’re thinking of creating a crypto token, or are involved in listing, trading or storing them, you’ll need to understand what type of financial
product you’re dealing with and how that’s regulated. If you need help doing this or in creating a framework that will allow you to self-assess multiple
tokens, get in touch. We’d be happy to help.
Jaime Lumsden Kelly

August 2019

There is a conflict any time a financial adviser recommends an in-house product, but the conflict can be managed.

ASIC has determined that conflicts with in-house products do exist

In its Report 562,
ASIC looked at the big five financial service institutions – CBA, Westpac, ANZ, NAB and AMP – and found that 68% of their client’s funds were invested
in in-house products. Looking at 200 files where clients switched from external to in-house products, ASIC found that 75% failed to demonstrate compliance
with the best interests duty (i.e. the safe harbour). Around 10% of those files contained advice that left the customer significantly worse off.
In many cases ASIC found that the client’s original product was perfectly capable of meeting their needs and objectives, and so replacing them was ‘unnecessary’.
It would be naive to think that such conflicts only occur at the big end of town. The same conflict affects many small to medium-sized advice businesses
(including those that use managed accounts). We know that ASIC’s managed account project is focusing on a number of issues including fees, suitability
and – you guessed it – conflicts!
Can financial advisers still recommend in-house products?

The conflict priority rule is an important element of what ASIC calls the ‘best interests duty and related obligations’. It requires a financial adviser
to prioritise the interests of their client above their own interests and the interests of their licensee or corporate group. The Royal Commission
made it clear (if it wasn’t already) that a conflict arises whenever a financial adviser recommends an in-house (or related party) product.
While in-house product recommendations are not prohibited pursuant to the Corporations Act or the FASEA Code of Ethics, advisers need to take appropriate
steps to prioritise their clients’ interests above their own. It’s not enough for an adviser to merely disclose the conflict. The adviser must explain
why the in-house product is likely to leave the client in a better position and how it is more likely to satisfy the client’s needs and objectives
(vs the client’s existing product).
This explanation should be captured and properly documented as part of the advice process. The message from ASIC is clear – if it’s not documented on file,
it didn’t happen. In Report 562 and Report 515, ASIC pointed to the fact that often there was nothing on file to demonstrate that the adviser had complied with the
best interests duty (and related obligations). So even if the adviser hadn’t breached the law, there was no evidence that the adviser had
complied with the law.
What if an in-house product isn’t appropriate?

An in-house product isn’t going to be appropriate for every client that walks in the door. When this occurs, the adviser has three options:

Research other financial products that may be more appropriate for the client;
Refer the client to another adviser who can help them; or
Politely decline to advise the client.

When should an adviser consider switching a client to an in-house product?

If a client has an existing product, you may consider recommending a switch to a new product (including an in-house product) if it is in the client’s best
interests to do so. A good time to consider a switch is if the client’s existing product is inappropriate for them, taking into account their needs
and objectives.
However, if the client’s existing product is appropriate for them and capable of meeting their needs and objectives, it will be difficult to justify a
switch.
Before you recommend a switch to an in-house product, you should:

Properly research your client’s existing product;
Conduct a comparative analysis of the existing product vs the in-house product. You may consider including a third (external) product that is capable
of meeting the client’s needs and objectives. This gives your client a better idea of the options available to them and the pros, cons, risks and
costs of each option; and
Capture your research on the client file and summarise it in the Statement of Advice.

Generally, it will be difficult for you to justify a product switch if:

The benefits of your in-house product are lower than the client’s existing product; or
The costs of your in-house product are higher than the client’s existing product.

The best recommendations are usually easy to explain. If you are struggling to justify or explain your recommendation to switch to an in-house product
– stop and reconsider it.
If you have any concerns or need more clarity about how to navigate the best interests duty and conflict priority rule, please get in touch.
We’d be happy to help.

Simon Carrodus

August 2019

The sale of financial advice portfolios is on the rise and both buyers and sellers are finding new ways to allocate risk. In this post, we put the
current deal trends under the microscope.

Following the Royal Commission, and as we move towards the deadlines for new FASEA requirements to be implemented, it’s become a buyers’ market. Buyers
are keen and empowered to limit their exposure and risk to changes to remuneration and poor advice. One way they’re doing this is by imposing more
stringent warranties and indemnities in their portfolio transfer agreement.
Buyers are asking for deeper warranties

A warranty is a promise by one party that a particular statement is true and may be relied upon by the other party. For example, a seller may warrant that
certain compliance requirements have been met (for example, opt-in and Fee Disclosure Statements), or warrant the levels of recurring revenue to support
the purchase price/value of the sale.
Following the Royal Commission, buyers are more vigilant than ever about the quality of the portfolios they acquire. They are conducting a more extensive
due diligence process and asking for better warranties than they have for similar transactions in the past. Buyers also want more certainty around
the payment of any PI claims, especially with so many advisers leaving dealer groups who are shutting down their FP operations entirely.
Buyers now expect warranties to cover things like:

Conduct in servicing clients: This may include the type of services provided, what advice was given, the products issued, compliance
issues and even the ‘client to advisor’ ratio.
Remuneration: They often want confirmation that fees were not charged where no services were provided, no grandfathered remuneration
is included and no clawbacks for overcharging fees.
Records: Warranties that electronic records are complete and in a satisfactory state to service the clients and deal with client complaints/claims.

To mitigate their risks, buyers are also asking sellers to give personal (owner/director) guarantees for these types of warranties.
The rationale behind these requests is to push the risk exposure back onto the seller as much as possible for poor advisory and compliance practices, allowing
the buyer to reduce the purchase price for any adverse impact on recurring revenue and retention of the acquired client base. This isn’t entirely unreasonable
given the seller is the one who ‘knows’ the clients, the business and its risks.
Sellers can still limit their exposure and risk

Sellers can counter warranty extensions requested by buyers to limit their exposure and risk. My recommendations for this include:

Cap the amount the buyer can seek for breach of warranty: Determining the amount of the cap is almost always the
subject of much negotiation. My view is that a seller shouldn’t accept a higher exposure, and a buyer shouldn’t accept less protection, than the
purchase price paid.
Cap the time period to make a warranty claim: This gives the seller certainty around their exposure. How long this
period should be is usually dictated by any period of deferred payments of purchase price. If it is in instalments over 2 years for example, then
a 2 year time period is probably a good compromise, but the exposure for indemnity claims (i.e. 6 years) may be longer, so this needs to be considered
carefully.
Set a minimum loss threshold: This can be drafted so that the buyer must suffer an individual loss or an aggregate
amount of $X before they can make a warranty claim. What $X is will be contingent on the purchase price and subject to negotiation between the
parties. I suggest 3-5% of the purchase price is fair and reasonable in most transactions. Noting that sometimes the parties will set it as the
amount of the excess/deductible under the Seller’s PI insurance.
Set the process: Sellers may want to impose a formal process for how buyers can make a warranty claim. This should
be in the agreement and include what notice and information the buyer must give to the seller before they can make a claim and during the process.
This is particularly important if the warranties are extensive, the warranty period is long, or the monetary warranty cap is high.

Indemnities are also gaining favour with buyers

Indemnities are a contractual obligation by one party to reimburse the other when an agreed event happens. In the current risk-averse landscape, buyers
are seeking to impose catchall general indemnities for any liability arising from the seller’s activities. A better compromise is for the indemnity
to cover any breaches of the law, legal negligence, or claims involving clients. Arguably, some of these indemnities are excessive and go beyond what
is really needed to protect the buyer, so sellers should resist these and only agree to specific indemnities.
Specific indemnities are items identified or disclosed in the due diligence process that can’t be resolved because the issue is ongoing where the potential
loss is not quantifiable at that time. If the issue can be finalised before completion or dealt with by adjusting the purchase price then it should
be done through a reduction to purchase price, rather than relying on indemnities.
In every sale transaction, counterparties obviously have competing interests. The key is understanding these interests and appropriately addressing them
in the sale agreement. As a buyer, you want to have certainty about your rights to claim against the seller and the seller’s financial resources to
meet indemnity and warranty liability. It is essential that the buyer has confidence in the PI insurance arrangement for the seller’s exposure in the
period after the sale. Without this, the indemnities are worthless because there will be no safety net for these risk exposures. Equally, as a seller
you want to know what your liabilities and obligations to the buyer are and when they will end.
If you’re negotiating or preparing to sign a portfolio transfer agreement, you should seek legal advice to make sure you’re mitigating your risk and exposure
under the agreement. If you would like any other information on tricks and traps for undertaking divestments, mergers and acquisitions, please get in touch.
We’d be happy to help.
Katie Johnston

August 2019

 
We’re delighted to announce that Simon Carrodus, who joined The Fold in early 2018, has been promoted to Solicitor Director. Simon leads our wealth management practice, and whilst many know him for his colourful analogies and straight-talk, it’s Simon’s deep understanding of the financial services regulatory framework that we (and our clients) value most.
Simon brings together his experiences working for the regulator (ASIC), in funds management, banking and large law firms to provide innovative solutions
to many of the challenges faced by organisations today. In the post-Royal Commission era, Simon provides financial advice to clients grappling with
a diverse range of issues including vertical integration, conflicted remuneration, remediation and dispute resolution.
Simon joins Solicitor Directors Charmian Holmes and Jaime Lumsden Kelly,
CEO Emma Zadow and Chairman Claire Wivell Plater in leading The Fold in our next chapter of growth.
Simon’s practice complements Charmian’s continued focus on the insurance sector, and in particular insurtechs and alternative risk transfer methods, and
Jaime’s expertise in the regulatory framework surrounding both financial services and credit. They’re supported by a talented team of professionals
who each bring unique skills and experience to our growing practice.
Most recently, Michele Levine joined our Sydney office as a Senior Associate. Her broad
experience covers all aspects of regulatory compliance and remediation as well as managed funds, corporate governance, product design and distribution.
Michele works closely with Jaime to find new ways for fintechs to fit their square pegs into the round holes of our regulatory framework.
While Michele helps our clients work within the system, Senior Associate Katie Johnston finds new ways for them to change how they operate. Based in the Sunshine State but working with clients nationally, Katie joined The Fold in early
2018 and co-leads our corporate advisory and M&A practice with Charmian. From raising capital to restructuring, buying client portfolios or making
an exit, Katie specialises in navigating transactions to help organisations realise their potential. Nothing gives her more joy than watching a transaction
unfold just the way she planned.
Working alongside our team of regulatory and corporate lawyers is our Head of Licensing, Sónia Cruz.
A reformed financial planner, Sónia has personally handled 350+ AFS and credit licence applications and variations. She’s adept at looking for practical
ways for businesses to manage their complex compliance requirements and is who you want on your team when liaising with ASIC on licensing matters
Responsibility for supporting each of our Solicitor Directors and Senior Associates sits on the very capable shoulders of our two Associates, Chris Deeble and Julie Hartley. Responsible lending, privacy and credit regulation are sweet spots for
Chris who cut his teeth working through customer complaints at the Credit and Investments Ombudsman, while Julie builds on her experience working with
superannuation funds to provide advice on discretionary mutuals and other aspects of ASIC regulation.
As our team expands, so does the breadth and depth of the experience that our clients can benefit from. Each person that we bring into The Fold has been
handpicked, not just for their legal expertise and experience, but also for their practical approach and personable style that is unique to The Fold.
We’re thrilled to have such a well-rounded and talented team to help you.
August 2019
 

Financiers who distribute through retailers may need to vary their licence in preparation for the end of the point-of-sale (POS) exemption.

The exemption was flagged to go by the Royal Commission. The credit representative model is the most obvious one to replace it. This will place financiers in a similar position to those who distribute insurance through the same or similar networks—but there’s a catch.

Authorisations work differently on AFS and credit licences

Insurers with AFS licences are able to appoint representatives without needing to vary their licence. However, authorisations work differently on credit
licences. In most cases, financiers won’t be able to appoint credit representatives without varying their credit licence.
On both AFS and credit licences, there are two key types of authorisations relating to the transaction (ignoring the question of advice). For AFS licences,
these authorisations are broadly arranged as:

Issuer, and anyone acting on behalf of the issuer; and
Agents of the client.

This is intuitive and works. It means that an insurer’s agent or anyone who performs part of the insurer’s tasks needs the same authorisation as the insurer.
This makes sense because the insurer is delegating part of its activities.
For credit licences the authorisations are arranged as follows:

Credit providers and lessors; and
Everyone else – including intermediaries of all kinds, whether they act for the financier or the borrower.

This is not based on practical functions like the AFS licence authorisations. Credit authorisations are based on whether you’re a lender or lessor or not.
So if you’re not a lender you need a different authorisation even if you’re acting on behalf of the lender.
The practical implications of this are that credit providers need one authorisation to run their lending business, and another if they want to appoint
agents or delegate certain functions. So if a credit provider wants a credit representative to act on their behalf they need another authorisation.
While some credit providers have both authorisations, many financiers will only have a lending authorisation. This means anyone who doesn’t currently appoint
credit representatives or operate their own intermediaries or credit assistance providers, will not be able to appoint credit representatives. Examples
include Flexirent, Flexicards, Latitude Finance and ZipMoney.
Obtaining new authorisations may not be easy

Many credit providers who want to appoint their retailers as credit representatives will need to vary their licence to obtain the authorisation they need.
But lenders may find it challenging to secure this authorisation. This is because lenders will need to nominate a Responsible Manager (RM) with expertise
in acting as an intermediary to support the new authorisation.
Most existing RMs will not have this expertise unless they’ve worked for a broker or other intermediary before. This requirement is ridiculous because
an RM who is competent in overseeing lending activities should be equally competent to oversee those lending activities when delegated to a credit
representative. However, it remains to be seen whether ASIC will accept an RM’s experience as transferable because there’s no clear guidance on this
point.
Historically, ASIC has been willing to accept an RM’s experience as transferable for similar financial services. For example, it has accepted general insurance
competence demonstrated via reinsurance experience or life insurance experience demonstrated via general insurance experience in personal accident
and illness. But in recent years ASIC has been less flexible with its competency requirements.
It can also take between 4 and 12 months (in some rare cases) to vary a credit licence. So if you’re a credit provider who is considering appointing your
POS retailers as credit representatives, you should consider varying your credit licence sooner rather than later.
If you need help assessing your RM’s competence, varying your credit licence, or determining how to manage your arrangements when the POS exemption ends,
please contact us.
Jaime Lumsden Kelly

July 2019

Add-on insurance has already come under intense scrutiny and regulatory action. In the latest blog in our Royal Commission response series with Finity we look at the likely regulatory approach to add-on insurance, including the regulation of different add-on products.

If you need advice on what the Royal Commission recommendations mean for your business, get in touch with The Fold’s team of experts.
In case you missed you missed them, here are the other blogs in this series:

Unfair Contracts
Claims as a Financial Service
Anti- Hawking
Enforceable Industry Codes
Design & Distribution Obligations

Finity is a leading consulting firm with deep domain expertise in the general insurance sector. With actuarial, claims, risk, operations and strategic advisers, along with a cadre of data analytics specialists, the firm has become a trusted adviser to many insurers in the Australian market. Highly regarded for understanding of each client’s business and providing actionable, management-oriented advice. Finity was awarded the Insurance Industry’s Professional Services Firm of the Year in 2018. www.finity.com.au
Jaime Lumsden Kelly,
The Fold Legal; Geoff Atkins, Finity
July 2019

 
ASIC rejects 30% of AFS licence applications and 24% of credit licence applications. In this article, we explain why it rejects applications and give you
tips on how to avoid becoming a statistic.
In 2017/2018, ASIC approved just 40% of all Australian financial services licence (AFSL) applications and 49% of credit licence applications. Many licence
applications could have avoided rejection with a little extra preparation.
When applying for a licence, ASIC performs a key role as a gatekeeper. It may grant a licence if:

The application is made in the prescribed format and all the supporting documents are provided;
It has no reason to believe the applicant is likely to contravene the general obligations applicable to all licensees. These obligations are outlined
in the Corporations Act and the National Consumer Credit Protection Act (NCCP Act); and
Anyone responsible for performing duties under the licence are of good fame and character. This includes responsible managers, partners and trustees.

Why ASIC may reject your licence application
There are 5 common reasons why ASIC may reject a licence application.
1. The application did not include all the information
When ASIC receives a licence application, the first thing it does is make sure it’s complete. If the application is incomplete it will be rejected and
you will need to reapply.
To submit a complete application it must include:

All core proofs and supporting documents outlined in ASIC’s Regulatory Guide 2 or 204 (whichever is applicable); and
Any other information required for ASIC to conduct a detailed assessment.

You must include all the information in the format prescribed in the guide. When putting the information together, remember it’s your chance to make a
good first impression on ASIC, so make it count.
2. It’s not clear what services you intend on providing
You need to be crystal clear about what products and services you will provide and how they are regulated. When reviewing your application, ASIC needs
to be reasonably satisfied that you will comply with your obligations under the Corporations Act or the NCCP Act. So you need to show ASIC that you
understand the law and what it means to your business.
For example, if you intend on advising on warrants, your application must be clear about what type of warrants and how they’re legally categorised. This
is because warrants can legally be securities, derivatives or managed investment schemes. If it looks like you have misunderstood the regulated nature
of your products or services, you will not inspire faith in ASIC.
3. Your responsible managers are unsuitable
Your responsible managers have direct responsibility for significant day-to-day decisions about your financial services. They must be able to collectively
demonstrate that they have the relevant qualifications and experience for all the product authorisations you’re seeking a licence for. If they can’t,
then they’re not the right people to be your responsible managers.
4. You can’t show how you will meet your statutory obligations
ASIC wants to know how you’re going to manage your business and embed your compliance arrangements. They may want to see that your processes and policies
are well documented. For example, ASIC may ask to see procedures that document how you will manage representatives, training, compliance, risk, disputes
and your compensation arrangements.
They may also ask to see documents that show your product research or demonstrate that you have adequate resources. For example, in a recent AAT decision
one of the reasons a licence application was rejected was because the applicant couldn’t adequately demonstrate how they would manage their financial
resources i.e. they had no documented policies and procedures for managing their financial resources.
If you’re applying to be a lender, ASIC may also ask to see your responsible lending and financial hardship policies.
5. You don’t respond to ASIC’s questions in a timely and adequate manner
If ASIC asks you for information, you’re expected to respond in a timely and adequate manner. For example, applicants usually have 10 business days to
supply additional proofs. If you don’t provide the information or ask for an extension, your licence application may be rejected.
ASIC will look at how you communicate and conduct yourself during the process when assessing your licence application. If you don’t provide some information,
it may be enough to satisfy ASIC that you can’t ensure that the “financial services covered by the licence are provided efficiently, honestly and fairly”.
By following these tips you can maximise your chances of getting your licence approved on your first attempt.
New factors will also affect licence applications soon
Recommendations from the ASIC Enforcement Review Taskforce will also impact the future assessment of licence applications. If these are adopted, ASIC may
be able to:

Refuse a licence application (or, for existing licensees, take licensing action) if it’s not satisfied that the entities or persons controlling the
licensee are fit and proper;
Cancel a licence if the licensee fails to commence business within six months;
Refuse a licence application if it’s false or misleading in a material way;
Require applicants to explicitly confirm that there have been no material changes to the information they gave in their application before their licence
is granted;
Align the assessment requirements for AFS and credit licence applications so that the highest standard applies; or
Align the consequences for making false or misleading statements in documents it’s provided with.

If you’re preparing or resubmitting your licence application, we suggest having it reviewed before you submit it to ASIC. This includes ensuring you have
all the core, complex product and additional proofs you require and that your responsible managers meet ASIC’s requirements.
If you need support putting together the required compliance documents and policies, we have a range of templates that you can use. We can also help you put together or review your licence
application and liaise with ASIC.
Sónia Cruz

July 2019
 

Discretionary mutuals are often driven by the desire to join together for a common purpose, but they can be expensive to establish. A recent legislative change has now created a new opportunity for mutuals to raise start-up capital through Mutual Capital Instruments.

What are Mutual Capital Instruments (MCIs)? 

Recent changes to the Corporations Act mean that qualifying mutuals can now issue MCIs to investors. This is a new way for mutuals to raise capital while
still meeting the requirements, including the ‘principles of mutuality’ for preferential income tax treatment.

Up to now, mutuals haven’t really had a choice but to fund their capital requirements including establishment costs outright. Often this is done by subsidising
these costs through increased member contributions or membership fees in the first few years of operation. This cost can be upwards of $120,000 with
licensing, legal and administrative expenses.

MCIs now provide an alternative allowing the introduction of a new ‘investor class’ with limited participatory rights. MCIs can be equity or debt instruments.

MCI holders do not have equivalent rights or access to the benefits that are provided to members of a mutual but they are entitled to receive dividends
or distributions. MCI holders do have voting rights, but irrespective of how many MCIs they hold they only get one vote. The interests of the members
continue to be given priority. MCI holders also cannot access surplus funds held by the mutual and their dividends are paid after all expenses including
claim provisions.

How does a mutual issue MCIs? 

A mutual has to meet 4 requirements before it can issue MCIs. It must:

Be a public company – this can include a company limited by guarantee but excludes mutuals structured as a trust;

Not have voting shares on a prescribed financial market – this includes the Australian Stock Exchange, the Sydney Stock Exchange
(previously the Asia Pacific Stock Exchange) or the National Stock Exchange of Australia. It can hold voting rights in MCIs though;

Be registered under the Corporations Act – this means it can’t be a charity or co-operative registered under State or Territory legislation;
and

Have a constitution that confirms its intention to be an MCI under the Corporations Act – if it doesn’t, the constitution of the
mutual will need to be amended.

As MCIs are a security, ASIC’s disclosure obligations do apply. This means that a prospectus must accompany any offers made to the public. However, start-ups
and small mutuals can make offers as part of a seed capital raise and avoid costly disclosures if they are proposing to raise capital from sophisticated
or wholesale investors, venture capitalists or financial institutions. A simpler offer document, like an information memorandum, can be used for those
types of offers and this allows mutuals to access funds faster.
When and where to use MCIs? 

MCIs may give some discretionary mutuals a more flexible option than using subordinated debt arrangements or raising capital through a related company
like the mutual manager (using a share offer or crowdfunding) and this can be helpful where the stakeholder group is focussed on seeking investments
from sophisticated and wholesale investors. But those investors must be willing to forego liquidity preference rights and ‘first in, first out’ rights,
which are hallmarks of a traditional VC-backed round.
How can you take advantage of this opportunity?

If you’re an existing mutual, you will need to change your constitution to issue MCIs. The legislation includes a simplified procedure to do this that
you can use until 4 April 2022. After that you’ll need to change your constitution by the rules contained in that document.
If you’re establishing a mutual, your constitution must include the right to issue MCIs before it’s adopted by the initial member. It’s also important
that the members, the Board and the MCI holders understand the process behind the ranking of debt to the MCI holders when it comes to surplus and winding-up
rights.
If you need advice on preparing for a capital raising or would like more information about how to use MCIs, please get in touch. We’d be happy to help.
Charmian Holmes and Julie Hartley

June 2019

New responsible lending rules have changed the way brokers and lenders should now calculate credit card costs in all lending applications
.

In the first part of this series, we explained
what the new responsible lending rules for credit cards are. These new rules also affect how you should calculate credit card costs in all other loan
applications when determining whether someone will be in substantial hardship.
What should you do?
Your responsible lending assessment of an applicant should be based on whether they can repay their existing credit card limits within 3 years. This means
you can’t just apply a nominal percentage to the total of all existing credit card balances any more.
When should you start doing this?

You don’t have time to sit back and think about this for too long – ASIC expects you to change the way you calculate credit card repayments by 1 July 2019.
What interest rate should you use?

When calculating how much an applicant will need to repay their credit cards, you should use the highest rate that applies under their contract. If you
don’t know what the highest rate is on their existing cards, you should use the highest rate that’s reasonably likely to apply. ASIC suggests that
this is 22%.
Should you include fees?
It’s not necessary to include all account-related fees in your assessment. But if you’re aware of fees that would significantly affect how long it would
take someone to repay their credit card limit then you should include those in your calculation.
What should you do now?
You need to review your Responsible Lending Policy to make sure it meets these new rules. In particular, look carefully at how you assess credit card repayments.
For further guidance you can also see ASIC’s Report 590.
If you need help reviewing your Responsible Lending Policy, get in touch, we’re happy to
help.
Chris Deeble

June 2019

This is the second blog in our Royal Commission Response series with Finity. In this blog we look at the recommendation to regulate claims handling as a ‘financial service’, including:

What the goal of the recommendation is;
How the recommendation may be implemented;
The definition of ‘claims handling’;
Which clients/ products would be protected; and
Who the obligations would apply to.

If you need advice on what the Royal Commission recommendations mean for your business, get in touch with The Fold’s team of experts.
In case you missed it, our first blog in this series looked
at how unfair contracts legislation may apply to insurance contracts.
Finity is a leading consulting firm with deep domain expertise in the general insurance sector. With actuarial, claims, risk, operations and strategic advisers, along with a cadre of data analytics specialists, the firm has become a trusted adviser to many insurers in the Australian market. Highly regarded for understanding of each client’s business and providing actionable, management-oriented advice. Finity was awarded the Insurance Industry’s Professional Services Firm of the Year in 2018. www.finity.com.au

Charmian Holmes, The Fold Legal; Raj Kanhai, Finity

March 2019