RG 126

October 2008

 

Regulatory Guide 126: Compensation and insurance arrangements for AFS licensees On 27 November 2007, ASIC released Regulatory Guide 126 (Guide), addressing how ASIC will administer the compensation arrangements that Australian Financial Services Licensees (licensees) who provide financial services to retail clients must have in order to comply with section 912B Corporations Act 2001 (it does not apply to wholesale clients).


A revised version of the Guide was released on 28 March 2008.


The Guide provides for a two-step implementation to ensure that, by January 2010, licensees will hold PI cover significantly increased in scope from that previously available. Licensees must take out ‘adequate’ PI insurance and have their own fund sufficient to cover any shortfall for claims made against them. The obligation is on the licensee to determine what is 'adequate' (using outside professionals such as brokers or actuaries where necessary).


What is considered ‘adequate’ during phase one is based on what is commercially available in the insurance market but, by 2010, the specified levels of PI insurance must be in place.


The Guide is aimed at consumer protection, in the aftermath of high profile collapses such as Westpoint. It presents challenges and opportunities for brokers and insurers, in particular given the likelihood of the insurance market hardening.


Stage one: "adequate" cover required to be in place by 1 July 2008

 

  • The amount of cover must have a limit of indemnity for any one claim and in theaggregate of at least $2M for licensees with total revenue from financial services to retail clients of $2M or less. If total revenue from financial services to retail clients is greater than $2M, minimum cover should be equal to actual or expected revenue, to a maximumof $20M.
  • The potential for claims by wholesale clients or claims that fall outside the scope of section 912B need to be taken into account in calculating the amount of cover, and it must either take into account defence costs or cover must be in addition to defence costs.
  • The policy must have at least one automatic reinstatement unless the limit of indemnity is at least twice the minimum limit of cover.
  • The policy must "indemnify the licensee against liability for loss or damage suffered by retail clients because of breaches of Chapter 7 of the Corporations Act by the licensee or its representatives".
    • it must include liability for fraud or dishonesty by directors, employees and other representatives of the licensee
    • the policy need not explicitly refer to "breaches of Chapter 7" or "EDR scheme" awards but must have the effect of providing cover for those breaches, and
    • the policy must be a "contract of professional indemnity insurance", meaning it must cover negligence, fraud and other misconduct relating to retail clients ordinarily covered by a contract of PI insurance.
  • The policy must not contain exclusions for EDR schemes, loss caused by conduct of representatives, fraud and dishonesty by directors, employees and other representatives or claims arising from incidents notified to ASIC and it must not have the effect of excluding such claims.
  • If the licensee had an "immediately previous" PI policy, it must provide retroactive cover to the earlier of the retroactive date specified in the "immediately previous" PI policy, or the commencement date of the first PI policy in a series of continuous policies.


Stage two: what constitutes "adequate" cover after 1 January 2010

 

Key additions to the requirements in stage one are:

  • Calculation of revenue should also take into account any revenue authorised representatives receive from providing financial services to retail clients.
  • The policy must cover products not on an approved products list (but in relation to representatives only)
  • Run off cover must be provided for as long as is reasonably practical but at least for a year.


Please do not hesitate to contact Amanda Ryding or Gavin Creighton of Colin Biggers & Paisley should you wish to know more.