Compliance: Theory and Practice in the Financial Services Industry
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IMPORTANT NOTE: These slides have been provided primarily for the use and benefit of students taking the "Compliance: Theory and Practice in the Financial Services Industry" course at Sydney University Law School. They are a summary only of the subject matter covered and are not intended to be, nor should they be relied upon as, a substitute for legal or other professional advice. In particular, it should be noted that the slides are not always verbatim quotes from the underlying source material and that material may have been abridged or paraphrased for presentational purposes. There also may have been legislative, regulatory or other developments since these slides were last updated that are not incorporated.
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|Licensing and Disclosure Requirements|
|ASX Operating Rules|
|CR r1.0.02(1) - Definition of Warrant|
|A warrant means a financial product:|
|(i)||a derivative under s761D; or|
|(ii)||a financial product that would, apart from the effect of s761D(3)(c), be a derivative for s761D, and is excluded by that section only because:|
|(A)||it is a security under paragraph (c) of the definition of security in s761A;|
|(B)||it is a legal or equitable right or interest mentioned in s764A(1)(b)(ii); or|
|(C)||it is a legal or equitable right or interest mentioned in s764A(1)(ba)(ii); and|
|(b)||that is transferable.|
It took the regulators 3 attempts to get this definition correct - the original definition in the FSR amendments to the CR (SR 319/2001) being amended or substituted by SR 41/2002 and 31/2003.
In relation to (a)(ii) above, s761D(3)(c) excludes from the definition of "derivative" anything that is a financial product listed in s764A (other than a derivative).
In relation to (a)(ii)(A) above, para (c) of the definition of "security" in s761A defines a legal or equitable right or interest in a share or debenture of a body to be a security and therefore a financial product captured by s764A(1)(a). In relation to (a)(ii)(B) above, CA s764A(1)(b)(ii) captures within the list of specific financial products a legal or equitable right or interest in an interest in a registered managed investment scheme (ie a managed investment product). In relation to (a)(ii)(C) above, CA s764A(1)(ba)(ii) similarly captures a legal or equitable right or interest in an interest in an unregistered managed investment scheme, other than one that is exempt (or if the scheme is operated outside Australia, one that if operated in Australia would be exempt) from registration under s601ED(1) (ie a wholesale managed investment scheme).
The effect of s761D(3)(c), therefore, is to exclude from the definition of "derivative" a legal or equitable right or interest in a share, debenture, managed investment product or interest in an unregistered wholesale managed investment scheme.
So the definition of "warrant" effectively boils down to a transferable derivative or a transferable legal or equitable right or interest in a share, debenture, managed investment product or interest in an unregistered wholesale managed investment scheme. You can think of this latter category as a derivative-like interest in a share, debenture, managed investment product or interest in an unregistered wholesale managed investment scheme.
This notion of transferability is central to the definition of "warrant" and what differentiates this category of financial products from futures and other derivatives. Futures and non-warrant derivatives are not generally transferable. If you want to dispose of your interest in a futures contract or non-warrant derivative, rather than transfer it, you enter into an equal and opposite contract on the relevant market that has the effect of netting out, or cancelling, the original position. This is referred to as "closing out" the position.
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|Licensing and Disclosure Requirements|
|||Persons who carry on a business of advising on, or dealing in, warrants need a financial services licence authorising them to provide that service or to be an authorised representative of such a licensee.|
|||If they deal with retail clients, they need:|
|||Financial Services Guide|
|||Statement of Advice for any advice given|
|||Product Disclosure Statement for any products provided or recommended|
|||To act in the best interests of the client|
|||To avoid conflicted remuneration and comply with ongoing fee requirements|
|||To warn if giving personal advice based on incomplete or inaccurate information or if giving general advice|
|||Dispute resolution systems|
|CR r7.9.07A Who is the Issuer of a Warrant?|
|(1)||This regulation applies in relation to warrants.|
|(3/4)||If the financial product is entered into, or acquired, on a financial market through an arrangement made by a financial services licensee, or an authorised representative of a financial services licensee, acting on behalf of another person:|
|(a)||the financial services licensee is not taken to be the issuer of the financial product; and|
|(b)||the warrant issuer is taken to be the issuer of the financial product.|
|(8)||In this regulation: warrant issuer, in relation to a warrant, means the person who determines the terms of the warrant, including the rights and conditions of the warrant, and is responsible for obligations owed under the terms of the warrant.|
As mentioned in Lecture 1, the concepts of who is the issuer of a financial product and when a financial product is issued to a person are important ones, since issuing a financial product may not only give rise to a need to have an AFSL, it may also be the trigger point for a requirement to give a Financial Services Guide, Statement of Advice or Product Disclosure Statement.
|CR r7.9.07A(1) and (2) Requirement to Have PDS for Warrants|
|(1)||This regulation applies in relation to warrants.|
|(2)||S1010A of the Act [which excludes securities from the PDS disclosure regime in Part 7.9] is modified by adding after s1010A(1):|
|(1A) Despite subsection (1), this Part applies in relation to a financial product to which regulation 7.9.07A of the Corporations Regulations 2001 applies..|
The effect of this is to ensure that warrants that may also happen to fall within the definition of security in CA s761 are caught by the PDS disclosure requirements for financial products in Part 7.9 rather than the prospectus disclosure requirements for securities in Chapter 6D. There is a corresponding provision in the regs under Chapter 6D (r6D.5.01) that excludes warrants from the disclosure requirements in that Chapter.
|CR r7.9.07A(5) Modification of PDS Requirements for Warrants|
|The following information may be taken into account for s1013F:|
|(a)||information that is, or is required to be, disclosed to the market in relation to the underlying thing from which a warrant derives its value, including information published by a market operator in relation to financial products (including warrants and types of warrants) in the form of market data or educational material which is generally made available to the public by the market operator;|
|(b)||other information that a market operator is required to disclose to the market, in accordance with the Act, including:|
|(i)||information that was required to be disclosed to the market operator; and|
|(ii)||information that the operator was required to disclose in order to meet its obligations under the Act; and|
|(c)||information that is generally made available to the public by a market operator in relation to financial products, including information published about a warrant that is entered into or acquired on a financial market in the form of market data or educational material.|
CA s1013F is the section which provides that information is not required to be included in a PDS if it would not be reasonable for a person considering, as a retail client, whether to acquire the product to expect to find the information in the PDS. Factors that can be taken into account in that regard include the extent to which the product is well understood by the kinds of person who commonly acquire products of that kind as retail clients and the kinds of things such persons may reasonably be expected to know.
|CR 7.9.07A(6) and (7) - Ongoing Disclosure for Warrants|
|(6)||A way in which the warrant issuer may notify a holder of a matter to which s1017B(3)(c) (continuous disclosure requirements) applies is by giving the relevant information to the operator of the financial market on which the warrant was entered into or acquired.|
|(7)||Part 7.9 of the Act applies in relation to a warrant as if the words "but not more than 3 months after, the change or event occurs" in item 1 of the table in s1017B(5) of the Act were omitted.|
ASIC has issued a Class Order CO 03/957, which addresses the inconsistent treatment of managed investment warrants, compared to the treatment of share warrants and stapled security warrants, under Part 7.9 of the Corporations Act. The class order harmonises the regulatory regime for warrants by removing the additional disclosure requirements that only applied to warrants over managed investment products under the Act.
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|CR r7.9.63A(2) Confirmation of Purchases and Sales|
|(a)||that is not the issue of a financial product (other than a derivative that is not a warrant);|
|(b)||in which a financial services licensee deals in the financial product on behalf of the holder of the financial product; and|
|(c)||by which the holder acquires or disposes of all or part of the financial product;|
|must be confirmed by the financial services licensee.|
|CR r7.9.63A(3) Confirmation of Issues|
|(a) to which CR r7.9.63A(2) does not apply; and|
|(b) by which a financial product is issued to a holder;|
|must be confirmed by the issuer of the financial product.|
The combined effect of the words in italics in CR r7.9.63A(2) and CR r7.9.63A(3) is that where a warrant is issued, the warrant issuer must confirm the transaction. Where a warrant is sold or purchased through a licensee, the licensee must confirm the transaction. Any other transaction in a warrant must be confirmed by the warrant issuer.
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|What is a Warrant?|
|||A transferable option or other derivative issued by a third party issuer and listed by the ASX under Schedule 10 of the ASX Operating Rules|
|||Trading warrants - shorter dated (eg knock out warrants)|
|||Investment warrants - longer dated (eg instalment warrants and endowment warrants)|
Click here for a copy of the ASX Operating Rules Schedules. Click here for a copy of the ASX explanatory booklet for warrants: Understanding Trading and Investment Warrants.
"Warrant" is defined in ASX OR 7100 to mean a financial instrument which gives the holder the right to acquire, or to require the warrant issuer to acquire, an underlying instrument or to be paid an amount by the warrant issuer to be determined by reference to the amount by which the price or value of an underlying instrument is greater or less than a specified price or value or by reference to the amount by which the number of an index is greater or less than a specified number. It also includes any other financial product that meets the definition of warrant in CR r1.0.02 and which ASX determines to be a warrant for the purposes of the Operating Rules.
The underlying instrument for a warrant may be a financial product, index, currency or commodity.
Warrants are to be differentiated from: (1) options to acquire a security or managed investment product by way of issue from the issuer; and (2) exchange traded options (ETOs) and contracts for differences (CFDs), which are standardised derivative contracts created and entered into under the trading rules of the Exchange.
A warrant issuer must comply with the Listing Rules in relation to the issue and despatch of holding statements or certificates, the transfer and transmission of warrants, and the establishment and maintenance of a register of warrant holders, as if the warrants were shares in a company (ASX OR Schedule 10.7.5).
|The Basic Features of Most Warrants|
|||Underlying instrument - a financial product, index, commodity or currency|
|||Exercise style American or European|
|||In some cases, barrier or cap levels|
|||In some cases, capital guaranteed|
|||Security for exercise covered or uncovered|
|||Settlement method deliverable or cash settled|
|||Transferability (see ASX OR Schedule 10.7)|
A warrant is said to be covered if the warrant issuer has placed the underlying instrument in a trust or similar custodial arrangement on behalf of the holder.
Warrants do not have standardised terms. Terms may vary significantly between different warrant types, between different series of the same type, and between different issuers. For each warrant series, the terms are specified by the warrant issuer in the offering circular.
|ASX OR Schedule 10.2 - Approved Warrant Issuers|
|Warrants may only be issued by:|
|1.||An entity which is prudentially regulated as specified in the procedures;|
|2.||A government, government body or instrumentality that has a guarantee by the relevant Treasury authority covering payments due by the proposed warrant issuer;|
|3.||An entity that:|
|||holds an AFS licence or a licence in another jurisdiction which makes it subject to adequate supervision of capital standards;|
|||in ASX's opinion has an low long term credit risk;|
|||has net tangible assets which in the opinion of the ASX are sufficient to support the proposed issue; and|
|||is acceptable to ASX;|
|4.||An entity which has a guarantor which meets the criteria in 1, 2 or 3;|
|5.||An entity which proposes to issue fully covered warrants and which is acceptable to the ASX; or|
|6.||Any other person or entity accepted by ASX.|
|ASX OR Schedule 10.3.3 - Requirements for Admission to Trading Status|
|Admission to trading status will only be granted to warrants if all of the following requirements are satisfied:|
|(a)||the warrant issuer has completed and given to ASX a form of application for admission in the form specified by ASX from time to time;|
|(b)||ASX has no object to the terms of issue;|
|(c)||the warrant issuer is approved by ASX under rule 10.2;|
|(d)||the warrant issuer has prepared and given to ASX a draft or final PDS or prospectus.|
|Where a draft PDS or prospectus is given under (d), trading must not commence until the final PDS or prospectus has been given to ASX.|
If the warrant is over an index which is owned by someone other than the warrant issuer, the warrant issuer must submit with its application a written authorisation from the index owner to use that index (ASX OR Schedule 10.3.7).
The terms of issue must include appropriate provisions for the adjustment of the exercise rights of the warrants in appropriate circumstances including, where the warrants are linked to cash market products of a listed entity, adjustments for reductions in capital, bonus issues, rights issues and capital restructuring and, where the warrants are linked to an index, the modification and discontinuance of the index (ASX OR Schedule 10.3.8).
The ability to amend the terms of issue is constrained by ASX OR Schedule 10.3.4, 10.3.5 and 10.3.6.
|ASX OR Schedule 10.3.11 - Market Making Obligations|
|A warrant issuer must with respect to each warrant series admitted to trading status either:|
|||ensure each warrant series has an initial spread of holders which, in the opinion of ASX, is adequate and reasonable; or|
|||on an ongoing basis ensure a reasonable bid and volume is maintained in the market for each warrant series for the period set out in the Procedures except in permitted circumstances.|
The permitted circumstances are defined in ASX OR Schedule 10.3.11.
|ASX OR Schedule 10.6 Warrant Issuer Reports|
|A warrant issuer must:|
|||immediately notify ASX of any information which, if not disclosed, might lead to the establishment of a false market in its warrants or that would be likely to materially affect the price of its warrants (ASX OR Schedule 10.6.3); and|
|||except in the case of fully covered warrants, lodge a statement of assets, liabilities and equity within 75 days of the end of the half year (ASX OR Schedule 10.6.6 and Procedure 10.6.6) and, in all cases, its printed annual report with the ASX within 3 months of year end (ASX OR Schedule 10.6.5 and Procedure 10.6.5). It must also make a copy of its annual report available to warrant holders on request (ASX OR Schedule 10.6.7).|
These reporting obligations also apply to any guarantor of the warrant issuer.
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