As an Australian Financial Services (AFS) licensee, you and your representatives will often be responsible for looking after other people’s money. Given this important duty, it is essential that your own business is solvent and is able to pay its debts as and when they fall due.
Financial conditions and solvency
Generally, as a licensee you are required to have available adequate resources (including financial, technological and human resources) to provide the financial services covered by your licence. This includes accounting and any other resources needed to monitor your solvency.
You are also required to have adequate risk management systems to deal with, among other matters, any potential threats to your solvency.
Under the conditions of your licence, you must be able to pay all your debts as and when they become due and payable. You must also have total assets that exceed total liabilities, as shown in your most recent balance sheet lodged with the Australian Securities and Investments Commission (ASIC), and have no reason to suspect that your total assets would not exceed your total liabilities.
There is also a general requirement that you have a positive cash flow position for the next three months, although there are a number of options for complying with this requirement. For more information, see Regulatory Guide 166 Licensing: Financial requirements (RG 166).
Additional duty of directors
If you are a director of a company, you have an additional duty to prevent insolvent trading by the company. This means that if you are a director of a company that incurs a debt and the company is insolvent at the time or becomes insolvent by incurring the debt, and there are reasonable grounds for suspecting that the company is insolvent or would become insolvent, you are responsible for this conduct. The penalty for breaching this provision is 2000 penalty units ($220,000), or imprisonment for five years, or both.
Insolvent trading may give rise to civil penalty actions where a director could be required, among other matters, to compensate the company. Courts also have the power to disqualify persons from managing companies for insolvent trading.
Reporting breaches
If you breach, or are likely to breach, any of your obligations as a licensee, including those relating to solvency, you must report the breach or likely breach to ASIC. You must lodge a written breach report with ASIC as soon as practicable, and in any case within 10 business days after becoming aware of the breach or likely breach. For more information, see Regulatory Guide 78: Breach reporting by AFS licensees (RG 78).
ASIC’s compliance reviews
ASIC reviews compliance with financial conditions and solvency on an ongoing basis. We check a licensee’s financial statements and lodgement history and follow up on any audit qualifications.
Our on-site reviews may consider a licensee’s systems and their financial controls for monitoring day-to-day operations, including compliance with financial conditions.
We may ask about a licensee’s relationship with its auditors and whether there were any delays during the audit process that might explain late lodgement of financial statements.
We may review management letters from the auditor and speak to the auditors if we have concerns about, for example, late responses to the auditor’s requisitions.
We may also check the cash flow statements to see how closely operating cash flows are aligned with net profits. We are interested in related party transactions if removing them means that the licensee has greater liabilities than assets.
Areas of concern
Although standards across the industry are satisfactory, ASIC is still concerned about the large number of licensees that lodge their financial statements late. We also believe that there are still too many licensees not meeting their financial conditions for periods of time.
We hope that the increased use of automated systems to identify problems will deal with some of these systemic issues and prevent licensees from breaching their financial conditions.
We also look forward to seeing clearly assigned responsibilities for managing risks and escalation policies that leave no doubt that management will be fully informed in the event of any exceptional financial activity or financial trends that might affect the licensee’s solvency.
If you look after other people’s money, your conduct and your business’s financial dealings must be above reproach. Confidence in the industry depends on this and ASIC will continue to monitor compliance in this area.
Jennifer O’Donnell is executive director, Compliance Directorate, Australian Securities and Investments Commission (ASIC).