As readers may be aware from previous Norton Rose Australia alerts, "Australian carbon credit units" and "eligible international emissions units" (for simplicity, referred to as 'Carbon Products') are deemed to be "financial products" under the Corporations Act 2001 (Cth) pursuant to changes made by the Carbon Credits (Consequential Amendments) Act 2011 (Cth). This is in line with the government's aim to "provide a strong regulatory regime to reduce the risk of market manipulation and misconduct" in relation to Carbon Products. The effect of the change is to apply existing aspects of the financial services regulatory regime under the Corporations Act to certain activities involving Carbon Products. In particular, characterisation of Carbon Products as "financial products" means that firms and intermediaries that are involved in transactions involving Carbon Products will need to assess whether such transactions trigger the need for an Australian financial services licence (AFS Licence).
On 22 November 2011, the Treasury issued 'exposure draft' legislation that will modify the application of the financial services regulatory regime under the Corporations Act (Exposure Draft). The draft changes reflect the government's original undertaking to effect "appropriate amendments to the regime to fit the characteristics of units and avoid unnecessary compliance costs". Submissions in response to the Exposure Draft are due by 13 December 2011.
This alert provides an outline of some of the key changes proposed under the Exposure Draft and provides guidance on whether or not a firm will require an AFS Licence in relation to dealings in Carbon Products.
Activities requiring a licence
Generally, a firm that undertakes any of the following activities (among others) in relation to financial products may be regarded as carrying on a financial services business and potentially require an AFS Licence:
- Provide financial product advice
- Deal in a financial product
- Provide custodial or depository services
- Make a market
Financial product advice?
As Carbon Products will be regarded as financial products, a firm that provides "financial product advice" in relation to Carbon Products will require an AFS Licence. The concept of "financial product advice" is broadly defined and would encompass a recommendation or statement of opinion that is intended to influence a person in acquiring, disposing of, or otherwise dealing in a Carbon Product, or that could reasonably be regarded as being intended to have such an influence. This could, for example, regulate certain marketing material issued by traders or intermediaries involved in Carbon Product trading.
There are however certain carve outs that mean that some advice will not be regulated as financial product advice, including a communication about a Carbon Product which consists only of factual information (although firms would need to ensure it is not presented in a manner that may reasonably be regarded as suggesting or implying a recommendation relating to a Carbon Product).
Dealing in a financial product?
'Arranging' for a person to acquire or dispose of Carbon Products could constitute "dealing" and may require an AFS Licence.
Also, a person that acquires or disposes of Carbon Products could also need to hold an AFS Licence. An exemption would be available however if the person deals in Carbon Products 'on their own behalf' (whether directly or through an agent).
The Exposure Draft proposes to supplement the 'on own behalf' exemption by introducing an exemption in respect of dealings in Carbon Products entered into on a person's own behalf or on behalf of a related body corporate or associate of the person. The exemption applies in circumstances where the dealing is for the purpose of managing financial risk in relation to the surrender, cancellation or relinquishment of Carbon Products provided the person does not deal in Carbon Products as the principal purpose of the person's business (Hedging Exemption). The Hedging Exemption would not apply if the person is also involved in the making of a market in Carbon Products.
The Hedging Exemption would also extend to firms that deal in derivatives over Carbon Products. Interestingly, the proposed Hedging Exemption is broader than the existing exemption for dealings in derivatives for hedging purposes as the existing exemption requires that the firm not deal in derivatives as a significant part of the firm's business (compared to the requirement under the Hedging Exemption that such dealings not constitute the principal purpose of the firm's business).
The existing "on own behalf" exemption and the proposed Hedging Exemption should enable many firms looking to deal in Carbon Products for compliance purposes to do so without needing an AFS Licence.
Separately, investment funds set up to invest in Carbon Products would need to be operated by a firm that holds an AFS Licence.
Making a market?
A person who "makes a market" in Carbon Products may also be regulated and require an AFS Licence. A person would make a market if they regularly state the price at which they propose to acquire or dispose of Carbon Products and other persons have a reasonable expectation that they will be able to regularly effect transactions at the stated prices.
A person would require an AFS Licence in order to provide a custodial or depository service in respect of Carbon Products. This would arise if the person holds Carbon Products on trust for or on behalf of another person. There are limited scenarios that could fall within one of the carve outs provided by the Corporations Act as not constituting the provision of a custodial or depository service, including:
- provision of such services to a related body corporate or associate of the provider; or
- the provider and its associates have no more than 20 clients in aggregate for all such services they provide.
Exemption for foreign persons dealing with Australian persons
Overseas based firms looking to deal in Carbon Products with Australian clients need to also consider whether their activities require an AFS Licence. The Exposure Draft will introduce an additional exemption available to a person who is not in Australia and who deals in, provides advice on or makes a market in Carbon Products on behalf of a "professional investor" in Australia. The exemption would also apply to dealings in derivatives over Carbon Products or dealings in foreign exchange contracts. A "professional investor" is defined to include (among others) a person who:
- holds an AFS Licence;
- is a body regulated by the Australian Prudential Regulatory Authority, other than a trustee of a superannuation entity;
- is a trustee of a superannuation entity that has net assets of at least $10 million;
- is a person that controls at least $10 million (including any amount held by an associate);
- is a listed entity;
- is an exempt public authority; or
- is a body corporate that carries on business of investment by investing funds received following an offer or invitation to the public.
Characterisation as a financial product will have other implications that need to be considered by firms that deal in Carbon Products. We have not sought to address these in any detail, however briefly, these include:
- the anti-hawking provisions, which restrict unsolicited calls or meetings with 'retail clients' in relation to dealings in Carbon Products (see below discussion in relation to 'retail clients');
- rules governing the handling of client monies ahead of the transfer of Carbon Products;
- rules aimed at preventing market misconduct, including insider trading and misleading or deceptive statements;
- disclosure requirements in respect of advertising, in particular, if distributed to 'retail clients'.
Also, firms that provide financial product advice to 'retail clients' will be subject to various disclosure and other compliance obligations of the kind that apply to financial planners. The Exposure Draft seeks however to modify the disclosure obligations to replace the need for a product disclosure statement (issued in respect of typical managed funds) with a more tailored disclosure statement addressing mandated carbon specific related warnings.
A key question will be whether a provider of financial services is providing services to 'retail clients' (as distinct from 'wholesale clients') as this will affect the type of AFS Licence required and will mean the firm may need to address various additional regulatory obligations targeted at protecting retail clients. Generally, a 'retail client' is a person that is not a 'professional investor' and does not fall within one of the other categories of 'wholesale clients' under the Corporations Act that capture certain high net worth persons or large businesses.
Helpfully, the Exposure Draft broadens the possible categories of transactions that would be considered to involve a 'wholesale client'. Potentially, a single transaction involving Carbon Products with an aggregate value of $500,000 or more would be deemed to be a 'wholesale client' transaction.
Deferred start date
The Exposure Draft will modify the Corporations Act to provide that Carbon Products would start to be characterised as a financial product seven months after the adoption of the changes proposed under the Exposure Draft. This will provide firms (and ASIC) with additional time to gear up for the new regime, including obtaining an AFS Licence where needed (or for firms with an AFS Licence, a variation to specifically cover Carbon Products).
Norton Rose Australia delivers the Advanced Diploma in Financial Licensing Management course offered by the Australian Financial Markets Association. Norton Rose Australia can assist with advice on the application of the new regime to firms that will be looking to undertake transactions involving Carbon Products, and if necessary, assist with an application for an AFS Licence.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.