The regulation of remuneration models in financial services

James Beaton

Partner, dispute resolution

Scrutiny of the financial services industry reached a fever pitch in Australia during the past year, with loud calls for a Royal Commission.

One of the key themes of this scrutiny was the remuneration and performance incentives offered to participants in the sector, and the influence of those incentives on the behaviour of participants when dealing with consumers and considering their best interests. 2017 will see further developments in this area.

Internationally, the Financial Stability Board (FSB) has committed that by the end of 2017 it will develop and consult on supplementary misconduct-related guidance for existing compensation standards, which could include details on the use and application of compensation tools including malus and clawback. It sees the reform of compensation practices as essential to building resilient financial institutions.

Independent of global initiatives, the febrile political and media environment in Australia has forced the Australian Bankers Association to grapple with the vexed issue of commissions on products offered to retail and small business customers. In July 2016, Australia’s banks initiated an independent review of product sales commissions and product based payments.

A new bill was introduced to the Commonwealth Parliament in February 2016 with the objective of implementing the recommendations of the 2015 Trowbridge Review. The bill removes an exemption for life insurance advisers receiving conflicted remuneration for life risk insurance products and enables ASIC to determine the acceptable benefits payable for these products. The bill lapsed when Parliament was prorogued for the 2016 Federal election but is expected to be reintroduced in the current term of Parliament.

One other significant initiative commenced in 2016 is the government’s request for ASIC to review mortgage broker remuneration structures and their effect on the quality of consumer outcomes. The scope of ASIC’s review includes the whole distribution chain and it anticipates that the review ‘will be relevant to many stakeholders in the home lending sector, including credit providers, aggregators and brokers’. ASIC’s report will be provided to government by the end of 2016.

The link between remuneration, risk and the best interests of the financial services consumer will continue to be an area of significant regulatory reform throughout the following year.

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Change on the horizon for Australian IP landscape

Robert Cooper

Partner, Dispute Resolution

Published in April 2016, the Productivity Commission’s draft proposals to reform patents and copyright law exemplify the significant change occurring in Australia’s intellectual property landscape.

The Commission recommended abolishing the innovation patent system and suggested that both business methods and software are no longer patentable in Australia. It also proposed reducing the duration of copyright from 70 years after the author’s death to 15 to 25 years after creation. Such reforms, if they come to pass, would strongly impact on investment, competition, trade, innovation and consumer welfare.

The Commission recognised the role played by international treaties in the structure of Australia’s intellectual property regime. However, it did not address the potential financial and reputational costs of attempting to renegotiate complex multilateral and bilateral arrangements.

Overall, these contentious proposals have been met with concerted resistance, and the Federal Government is yet to table in parliament the final report into Australia’s intellectual property system.

Rapid advances in digital technology are a major challenge to Australia’s copyright laws. Holders of intellectual property rights have been handed several weapons against piracy. These include the ability to force internet service providers to block access to online locations hosted overseas if their primary purpose is to commit copyright infringements.

This year, MinterEllison’s copyright team assisted a key digital client to make one of the first court applications for such an order. More businesses are likely to act upon this new legislation in the coming year.

Our patent dispute team's work on Australia's first biologics case places us at the forefront of assisting clients in this quickly evolving area, as global life science companies jockey to bring new treatments to patients. We are bringing 'out of the box' thinking to clients involved in life science regulatory disputes.

This might include helping them get a ground breaking product to market despite strong opposition from their competitors, or protecting a life-saving treatment from being undermined by ‘look-alike’ products.

In stark contrast to the dynamic approach to the law in Australia, the contentious Trans‑Pacific Partnership Agreement’s intellectual property rules continue to languish in the United States as the fractious political environment prevents their approval. They may well never come into force as no major presidential candidate publicly supports them.

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We need to do more than talk about innovation

Kylie Diwell

Partner, Commercial & Regulatory

2016 was the year of innovation talk. Prime Minister Malcolm Turnbull’s innovation agenda saw a ripple effect that included funding grants, tax incentives for investors and government-funded ‘Landing Pads’ for Australian entrepreneurs opening in key areas overseas.

Australia’s future prosperity will rely on our capacity to move towards a knowledge-based economy.  Our ability to maintain the post‑mining boom standard of living we’re accustomed to will ultimately depend on our ability to innovate.

The 2015 Australian Innovation System Report focused on innovative entrepreneurship and how it influences Australia’s innovation system. Some of the results were surprising.

It found that our exporters are not high performing innovators and our export diversity has, in fact, decreased over the past 15 years; most of our innovation is ‘new to firm’ not ‘new to market’ or ‘new to world’ and we rank low on business sophistication.

What can businesses do?
It’s time to build a culture of collaborative innovation where failure is seen as part of the process. Organisations need to commit to managing (even a small) portfolio of innovative initiatives, while the teams who work on these are allowed to operate autonomously, with the support of senior leaders.

We also need to develop systems that identify international opportunities and facilitate a network of partnerships so organisations can collectively learn from mistakes, solve problems and realise opportunities, to better manage risk.

We also need to invest more heavily in intangible assets, such as skills, data and intellectual property.

The legal industry’s role in facilitating this culture of innovation will be crucial.  We need to explain the value of such intangible investments.

We can also advise on practical risk management, considering it as a key part of innovative processes that should be managed – not avoided.

Maybe then, we can look forward to a year of innovation action. 

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A paradigm shift in aged care

Penelope Eden

Partner, Health and Aged Care

Never before has an industry experienced such a large paradigm shift as the current movement in the aged care industry from a regulated grant approach to a consumer-driven, competitive market environment.

The predicted future demand for aged care services has brought attention to the financial sustainability of the sector. It is estimated that around $31 bn will be needed over the next decade to accommodate an additional 76,000 older Australians. The demand implications of continued growth are further compounded by the increasing (and more expensive) care needs of older Australians.

The Living Longer, Living Better reform package introduced in 2012 included a ten-year plan to achieve a more sustainable and viable industry capable of providing high-quality end‑to‑end aged care solutions.

The reforms coincide with the government’s major policy trends: delivering services within the community, shifting funding control to consumers and the advent of activity-based funding.

Policy reforms have significantly impacted the behaviour of older Australians and trends within the aged care sector. Ageing Australians are increasingly accessing aged care services within their community, delaying entry into residential aged care. Home care has become a game changer, with 1 in 4 places now based in the community. Apart from the obvious cost saving to government, the evidence demonstrates that community-based care also yields better health outcomes for consumers.

The retirement living sector is playing an increasing role in the care of older Australians, largely brought about by the government policy of ageing in place’. In the past two years, a rapid transformation has occurred in the service offerings in retirement villages, with care now considered integral to the business model. 

More reform in home care is expected in February 2017. Relevantly, home care package funding will follow the consumer, making packages more portable. While this makes funding for providers uncertain, it affirms that the package belongs to the consumer and increases transparency by detailing how funds are allocated through individualised budgets, monthly income and expenditure statements.

The sector is in a rapid state of change resulting in increased contestability, less predictability in demand for services and the emergence of industry disruptors. While the changing landscape creates a degree of instability for operators, it is also a major opportunity.

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The changing shape and mix of Chinese investment in Australia

Adam Handley

China Markets Leader, Managing Partner, WA

Chinese investment in Australia has undergone a major shift in the past two years, both in terms of the sectors attracting investment and the nature of investors.

We have seen a significant decline in resources investment (heavily dominated by Chinese state-owned enterprise investors) and a rapid increase in real estate, health and ageing, agriculture, and innovation opportunities (led by Chinese private-owned enterprises).

Following the first wave in 2008, China’s investment in Australia has produced mixed results, with some disappointing collaborations and some wonderful ones, like the partnership between Legend Holdings and Kailis Bros Seafood.

To ensure the success of long-term investments, Chinese and Australian companies need to work harder to develop deeper cross-cultural understanding. This requires, on the Australian side, people who are interested in understanding different cultural, educational and religious upbringings and are dedicated to building genuine, long-term relationships with their Chinese business partners. On the Chinese side, it requires a commitment to learning how to do business in an international framework and to harnessing the local knowledge that Australian business partners can offer.

Australian public sentiment towards Chinese investment is a barrier to the progression of these beneficial foreign partnerships. If not managed properly, these attitudes – exacerbated by defence issues in the South China Sea and the China ‘soft power’ debate – could damage our nation’s future prosperity. Already, there is a growing perception in China that Australia may be a difficult place to conduct business.

If growth and prosperity for Australia is our goal, we must embrace greater cross-cultural understanding between our two nations, our businesses and our people. We need an informed discussion about the benefits to every Australian household of trade and investment with China. We also need a foreign investment process that proactively provides guidance to state-owned investors (from any country) about potential sectors or industries where state-owned investment will raise concerns or not be permitted.

The Foreign Investment Review Board and the Australian Treasury have made great strides towards making the screening process more transparent, particularly in the past 18 months. However, we still have some way to go.

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Opportunities for Australian managed funds

Stuart Johnson

Partner, Financial Institutions Group business unit leader

There have been several key developments in the past year that may help the Australian funds management industry increase its reach.

An important initiative is the Asia Region Funds Passport, which will provide a framework for the cross-border marketing of managed funds across the participating economies. Australia, Japan, South Korea, New Zealand, the Philippines, Singapore and Thailand have signed up for the passport, which is intended to begin after December 2017.

The 2016-17 Budget announced two new collective investment vehicles (CIVs) that are intended to operate as a tax-effective alternative to current Australian pooled investment trusts. The proposal is that a corporate CIV will start from 1 July 2017 and a limited partnership CIV will start from 1 July 2018.

The government also changed managed investment trust (MIT) taxation, and the Australian Securities and Investments Commission will now allow the trustees of registered MITs to change their funds’ trust deeds without holding members’ meetings. The changes also allow trustees to treat different classes of units separately for taxation purposes.

Finally, the government is considering altering the transparency rules – the so-called ‘look through’ requirements – on the disclosure of where superannuation funds’ portfolio holdings are located. In the most recent draft of the regulations, the ‘look-through’ rules have been significantly reduced to bring them into line with the Australian Prudential Regulation Authority reporting requirements. This would reduce the regulatory burden.

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Sharper focus on tax transparency

Carmen McElwain

Partner, Tax

International tax avoidance generated significant scrutiny this year.

Concerns are shared by the Australian Government and the public alike as to how the nation’s tax base is being affected by multinational entities using artificial arrangements to avoid attributing business profits within Australia.

Internationally, numerous actions are being undertaken to ensure that multinational corporations pay the appropriate amount of tax in countries where they conduct business and derive revenue. The OECD is focused on achieving tax transparency through its initiative to stop base erosion and profit shifting by multinational groups. This focus has led to the Government introducing country-by-country reporting laws requiring groups with an annual global income of $1 bn or more that derive income within Australia to provide information regarding revenue and profits to the ATO.

Following the 2016–17 Federal Budget, recommendations were also made for the Board of Taxation to work with the ATO to develop a Tax Transparency Code to prompt public disclosure of tax information. The Budget also proposed a diverted profits tax that would combat companies shifting profits offshore through related parties.

These recommendations and proposals pose an additional risk issue for multinationals to consider as part of their tax risk governance.

The Budget also recommended funding a new Tax Avoidance Taskforce to support the ATO’s audits and risk reviews of private company groups and high net wealth individuals. The ATO has also commenced its pursuit of taxpayers who did not take advantage of Project DO IT, an initiative that encouraged the voluntary disclosure of offshore income in exchange for limited retrospective action relating to prior year tax returns and not being referred to a criminal investigation, among other benefits.

In response to the Panama Papers leak, the Australian Commissioner of Taxation foreshadowed the ATO’s zero tolerance approach towards tax evasion schemes such as concealing income and assets offshore. The ATO has undertaken drastic measures such as raids on companies, high net wealth individuals and even accounting firms, without notice.

The Commissioner’s challenge going forward is to continue to engage multinationals, corporates and other entities, and reward those taxpayers that endeavour to be transparent and compliant. The Commissioner will also need to proactively pursue those taxpayers regarded as a risk to Australian revenue.

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Competition law reform

Paul Schoff

Partner, Commercial & Regulatory business unit leader

The federal government’s release of exposure draft legislation in September to amend the Competition and Consumer Act 2010 capped a busy year for competition law reform.

In late 2015, major changes to restrictive trade practices provisions were recommended in the final report of the Competition Policy Review, chaired by Professor Ian Harper. The government, having already indicated its support, has now invited comment on several amendments.

Firstly, the government wisely intends to clarify the operation of cartel rules and confine them to conduct affecting actual or likely competitors in Australia. This is a significant issue that preoccupied MinterEllison’s competition team for several years when representing Singapore Airlines during Australian Competition and Consumer Commission (ACCC) cartel enforcement proceedings. The creation of a broader exception for joint ventures is intended to deliver greater business certainty. 

The introduction of a competition test to third line forcing is long overdue, while the government has also sensibly proposed the abolition of unused bespoke price signalling laws.

However, concerns remain about the government’s proposal to amend the misuse of market power provision in section 46. The existing prohibition will be reframed to forbid corporations with a substantial degree of market power from engaging in conduct that has the purpose, effect or likely effect of substantially lessening competition. Yet there is no attempt to define or qualify the word ‘conduct’, leaving good and bad conduct to be characterised by the ‘purpose or effect’ competition test.

Contrary to suggestions by some commentators, this will not result in the sky falling down. However, it will create some uncertainty and risks undermining the confidence of businesses holding substantial market power as they chart their company strategy.

Another proposed change involves repealing the little-used formal processes to clear and authorise company mergers. These activities will instead be subject to the general ACCC authorisation process in section 88. The ACCC will have 90 days to determine the application, unless a longer period is agreed.

The Australian Competition Tribunal may review the ACCC’s determination on limited grounds, but will not re-hear the matter.

If these reforms come to pass, with some common sense adjustments, they will provide a welcome alternative to the current formal merger clearance process, while leaving informal merger processes intact.  

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