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Peter Stockdale  
Partner
T +61 2 9296 2330

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Philip Ward  
Partner
T +61 2 9296 2213

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Brisbane
Justin McDonnell  
Consider whether the issues and developments referred to in this publication may impact on your business. We can help.

Canberra
John Topfer  
Consider whether the issues and developments referred to in this publication may impact on your business. We can help.

Hong Kong
Stuart Valentine  (萬思陶)
Consider whether the issues and developments referred to in this publication may impact on your business. We can help.

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In March 2008 the Australian Securities and Investments Commission (ASIC) released Regulatory Guide 126 (RG 126), which sets out how it will administer the requirement for Australian financial services licensees (AFS licensees) to have arrangements in place for compensating retail clients for losses suffered as a result of breach of the licensee’s obligations under the Corporations Act 2001 (Cth) (Corporations Act). These obligations are primarily complied with by obtaining professional indemnity (PI) insurance cover. Since the release of RG 126, some recurring issues with compliance with RG 126 have been identified.

Minimum PI policy requirements for the implementation period

Table 5 in RG 126 sets out the minimum policy features required of an AFS licensee’s PI insurance during the implementation period (1 January 2008 to 31 December 2009), including:

• The insurance must be provided by an insurer regulated by APRA or operating under an exemption under the Insurance Act 1973 (Cth).
• The minimum permissible indemnity limit for PI cover effected by an AFS licensee providing financial services to retail clients is $2 million. For AFS licensees that derive or expect to derive more than $2 million from the provision of financial services to retail clients the minimum cover must be approximately equal to the amount of revenue so derived, up to a maximum of $20 million. Revenue received by authorised representatives of the AFS licensee is to be included for the purposes of determining the minimum sum of cover.
• The excess/deductible on the policy must be at a level that the licensee can confidently sustain as an uninsured loss. AFS licensees should assess the financial resources required to cover the policy excess and any gaps in cover and retain records of this assessment.
• The policy must indemnify the AFS 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 (such as employees and directors).

However, AFS licensees should be aware that ASIC has emphasised that its minimum requirements are merely a guide, and compliance with such requirements does not necessarily mean that a licensee has complied with the requirements of the Corporations Act and Regulations. AFS licensees are required to maintain records of how they determined the amount of cover they deemed adequate.

Issues identified by Industry

The financial services industry has identified potential anomalies in the minimum requirements prescribed by RG126, such as:

• RG 126 requires an AFS licensee’s PI policy to include cover for fraud and dishonesty by directors, employees and other representatives. Cover for fraud is usually excluded under an AFS licensee’s PI policy, but obtained by a Crime extension to the policy. There is some debate about whether this would satisfy RG 126, because technically it requires cover for fraud and dishonesty to be provided under a PI policy (rather than through an alternative policy section)
• RG 126 requires an AFS licensee’s policy to cover external dispute resolution (EDR) scheme awards. A policy must not have the effect of excluding EDR scheme awards. Many AFS licensees are members of the Financial Ombudsman Service Limited - an EDR scheme which has jurisdiction over disputes in relation to members where the sum in issue is not more than $280,000. However, where a PI policy has an excess greater than $280,000, this has the effect of excluding EDR scheme awards notwithstanding that the scope of cover includes such liability.

AFS licensees and their brokers should be aware of these issues when effecting their PI cover. Clarification as to the requirements of RG 126 can be sought from ASIC if required.