Revised credit crunch guarantee package

On Friday 24 October the Treasurer, Wayne Swan, announced changes to the Federal Government's response to the credit crunch, the Deposit Guarantee and Wholesale Funding Guarantee, and on 28 October, Treasury released "Design and Operational Parameters" for these arrangements.

In this Alert we summarise the arrangements as they currently stand.

Outline of the Package as it currently stands

The package, as it currently stands, involves:

a) a government guarantee for three years for deposits with ADIs (including Australian ADI subsidiaries of foreign banks) of up to $1 million regardless of where the depositor resides;

b) a government guarantee for three years for deposits with ADIs (including Australian ADI subsidiaries of foreign banks) of over $1 million where the ADI "opts in" and pays a fee (which can be passed onto its customers);

c) a government guarantee for three years for domestic deposits held by Australian residents with APRA regulated foreign bank branches subject to the foreign bank paying a fee and other conditions;

d) wholesale funding government guarantee on senior unsecured debt instruments for ADIs (including Australian ADI subsidiaries of foreign banks) on an issue by issue basis subject to a fee until market conditions normalise;

e) wholesale funding government guarantee in respect of their short term wholesale funding raised from Australian residents with maturities up to the end of 2009 for APRA regulated foreign bank branches subject to the foreign bank paying a fee and other conditions; and

f) the fee, where applicable, is to be levied annually and calculated based upon the credit rating of the ADI or foreign bank as follows:

 

• AA - 70 basis points
• A - 100 basis points
• BBB and unrated - 150 basis points.

 

History of the Arrangements

Although the Government was moving towards some form of deposit guarantee anyway, the global financial unrest spurred it into action. On 12 October 2008, it announced that in order to boost confidence, it would provide:

• a guarantee scheme for deposits that was not subject to any financial limitation;
• compensation to policyholders with claims against a failed general insurer; and
• a scheme for the guarantee of wholesale funding.

Legislation to establish the Financial Claims Scheme was rapidly introduced and passed by the Federal Parliament on 16 October 2008 (Financial System Legislation Amendment (Financial Claims Scheme and Other Measures) Act 2008, Financial Claims Scheme (ADIs) Levy Act 2008 and Financial Claims Scheme (General Insurers) Act 2008).

Following criticism of the scheme and a flight of capital from products which were not guaranteed, such as mortgage funds, the Treasurer announced modifications to the arrangements on 24 October 2008 and on 28 October, Treasury released "Design and Operational Parameters". Broadly, these announcements provided for the guarantee of deposits of over $1 million to be subject to a fee, set out the amount of the fee for deposits of over $1 million and extended the arrangements to APRA regulated branches of foreign banks in respect of Australian residents.

Deposit guarantee for ADIs

• The guarantee applies to deposits held in ADIs (including Australian ADI subsidiaries of foreign banks) for three years by all types of legal entities, including individuals, partnerships, businesses, trusts (including in their offshore branches) and government entities. It applies regardless of where the depositor resides and to deposits of all currencies;
• The guarantee will not apply to products that are not deposit products. It does not apply to market-linked investment products such as share portfolios or managed funds. It will also not apply to retirement income products including annuities;
• The guarantee will be free for deposits under $1 million and the fee set out above will be charged for deposits over $1 million on an opt-in basis. If an ADI opts in, it will be up to the ADI to determine the most suitable arrangements with its customers for those deposits it wishes to offer on a guaranteed basis. Depending on the arrangement chosen by the ADI, depositors may need to indicate to the ADI whether they wish to receive the benefit of the guarantee for amounts over $1 million. Treasury expects ADIs to pass on the costs of the guarantee to their customers; and
• This means that the $1 million threshold operates per depositor per institution (i.e. aggregating deposit amounts within the institution). Howeverthe position of depositors in different capacities remains unclear (eg. in their personal and trustee capacities or depositors with accounts in their sole names who also have joint, partnerships or JV accounts with others).

Wholesale funding guarantee

• ADIs (including Australian ADI subsidiaries of foreign banks) must apply to the RBA (as agent for the Commonwealth) for a guarantee to attach to eligible securities;
• The facility will be restricted to senior unsecured debt instruments. Certificates of deposit and bank bills will be covered by this facility. The guarantee will not cover structured debt;
• The guarantee will be extended on an issue by issue basis. Eligible securities will be restricted to securities issued by ADIs with a term of up to 60 months with the guarantee to apply for the full term of the relevant security including in the period following the closure of the scheme to new issuances;
• The facility will apply to debt issuance in all major currencies including AUD, NZD, Euro, USD, Sterling, Yen and HKD. It will apply to eligible securities issued domestically or off-shore;
• The Government will charge the issuing ADI the fee set out above for the guarantee; and
• ADIs will be required to meet set criteria specified in Rules before they receive coverage. The Rules will be released in the near future.

Foreign bank branches

• APRA-regulated foreign bank branches will be able to access the wholesale funding guarantee in respect of their short term wholesale funding raised from Australian residents with maturities up to the end of 2009. This will be available for the fee set out above.
• Foreign bank branches will also be able to access the deposit guarantee in respect of domestic deposits held by Australian residents on the basis of the fee set above with no fee-free threshold.
• Access to these guarantees will be subject to:
  • The amount guaranteed be limited to 110 percent of the combined value of short-term wholesale liabilities and deposits held in respect of Australian residents as at 24 October 2008;
  • Branches cannot use guaranteed liabilities to support their parents; and
  • The guarantee is only available if the liabilities are not guaranteed by the home authorities and the branch provides a statement from the home regulator that the parent bank is meeting relevant prudential requirements.

Administration and legal framework

The "Design and Operational Parameters" states:

"The legal framework for the scheme will be deeds entered into by the Commonwealth and the participating institutions. The deeds will refer to scheme Rules that will be published by the Commonwealth."

It is unclear from this document whether this legal framework is intended to supersede the legislation that has already been passed or is merely to apply in relation to those aspects of the scheme that involve opting in and payment of the fee. If the latter alternative applies, it would mean that part of the scheme is legislative and is administered by APRA while the other part of the scheme is contractual and is administered by the RBA.

The "Design and Operational Parameters" appears to us to be drafted on the basis that the entire scheme is contractual and is to be administered by the RBA. It states that the RBA will "administer the guarantees as agent for the Commonwealth" and will perform administrative tasks - including processing applications from institutions for coverage of liabilities and collecting fees. There will be consultation between the RBA and APRA and the Rules will allow for information sharing between the RBA, APRA and other relevant agencies.

Finally, ASIC will monitor the operation of the guarantees to ensure that appropriate disclosures are made by banks to consumers so that they can determine if their product is covered by the guarantees. This suggests that banks will have to carefully consider the scope of their products covered by the guarantees and potentially will be expected to positively volunteer whether or not a particular product is covered by a guarantee.

Transition, commencement and review

The "Design and Operational Parameters" states that the "guarantee scheme commences on 28 November 2008 and until then deposits and wholesale guarantee arrangements will be guaranteed without charge. It is difficult to understand this statement in relation to the wholesale guarantee because until now the announcements about this guarantee have stressed that it is subject to a fee and required a specific application by an ADI. Additionally the "Design and Operational Parameters" makes it clear that the arrangements may require refinement or adjustment in light of market developments and will be reviewed on an ongoing basis and revised if necessary.

Non-prudentially regulated investment sector

The "Design and Operational Parameters" states:

"The Secretary to the Treasury and the Chairman of ASIC will examine immediately (in consultation with industry) the impact of the global financial crisis on the non-prudentially regulated investment sector and, in consultation with the other financial regulators, will provide advice to the Government as soon as possible on what actions might be appropriate to foster the ongoing health and vitality of this important sector of the economy."