ESC 18: An Overview
The Corporations (Aboriginal and Torres Strait Islander) Sector Code of Best Practice Compliance (ESC 18) is a ground-breaking voluntary code that sets out the minimum legal requirements that must be met by all signatory corporations (including their directors and employees) who use or store Indigenous cultural and intellectual property (ICIP). It is designed to support the carriage of Indigenous and First Nations peoples’ culture-authorised rights by protecting Indigenous stories, knowledge and language from appropriation, translation or re-interpretation without the consent of the custodian .
Underpinned by Indigenous rights, settlement arrangements and the ‘Respect’ outcome, clause 6 of the National Native Title Council’s (NNTC) Guidelines for Best Practice in Native Title and Indigenous Land Use Agreements, ESC 18 aims to foster the capacity of signatories to enter into agreements with Aboriginal and Torres Strait Islander Peoples, based on mutual respect.
Although largely unexamined, the Code is significant in its collective industry focus. It is also significant because in the recent Federal Court case of NT WorkSafe v TK, the Court expressed concern that NNTC had not adopted the Code as a compulsory standard as part of the application process for acquiring a work health and safety licence. As one of the first test cases, it will be a watershed moment.
The Key Aspects of the ESC 18 Legal Framework
The ESC 18 jurisdiction website lists the governing legal framework as comprising the European Union’s Capital Requirements Directive IV ("CRD IV") and Capital Requirements Regulation ("CRR"), that set the prudential requirements of the relevant undertakings of the ESC 18 group. The CRD IV directive is complemented by the Alternative Investment Fund Managers Directive ("AIFMD") and AIFMD-Level 2 regulatory and implementing technical standards. The law applying to the UK Prudential Regulation Authority ("UK PRA") regulation equivalent (in particular, the UK CRR and the UK Capital Requirements Directive 2013 Regulations) applies to the UK undertaking within the group (i.e., Scottish Widows Bank PLC). In addition, if the UK banks within the group wish to enter into transactions with any US banking entities that are registered with the US Federal Reserve, those transactions will be subject to section 165 of the Dodd Frank Act, also known as the "Volcker Rule."
ESC 18: Compliance Requirements
In order to ensure that information required by an entity to be disclosed under the ESC 18 is adequate, the following should be taken into consideration:
1. Statements regarding prior auditor independence with respect the entity
The general SEC staff’s position is that, in assessing whether there has been a change in the principal auditor, all relationships and services between the issuer and the predecessor audit firm (or an individual employed by that audit firm) and the entity (with limited exceptions) must be considered.
If the SEC considers that the auditor and/or the company have failed to comply with the independence rules or requirements, the SEC might reconsider its determination and deem the relationship as a change of auditors. In this case, entities should consider significant events such as changes regarding the types of services provided to the client by the auditor may be indicative of a "disagreeable difference".
During the course of preparation of the required filings, the audits committee should consider:
2. Meaningful discussion with the predecessor auditor
All entities that consult with and will provide an opinion on financial information filed with the SEC are required to consider the meaning of the word "discuss". The fact that the predecessor auditor prepared the financials does not necessarily mean that the predecessor auditor has "discussed" with the new auditor the factors which led to the decision to change auditors. It is possible that some of the facts below were known to the new auditor and not communicated to the predecessor auditor prior to the change of principal auditor and thus would not be "discussed" with the predecessor auditor:
3. Due Diligence Procedures
The entity should establish the due diligence procedures it will institute to comply with the requirements of the framework. Such procedures should be followed in connection with the decision to change principal auditors and will take into consideration the procedures summarised above. It should also be noted that many of these procedures might apply not only to resignations or dismissals from the auditing engagement, but might be applied in connection with matters negotiated at the initiation of a new engagement.
4. Forming a Reasonable Basis
The "reasonable basis" in connection with applying the provisions of ESC18 requires the exercise of professional judgment and is dependent on the materiality of the information disclosed on the form for example:
5. Decisions made on a reasonable basis should be adequately documented
6. Understanding disclosed information
Upon arriving at a decision on the disclosure issue (i.e., to comply with the framework) the entity must be familiar with the relevant SEC rules and regulations.
The Business Impact of ESC 18
For many businesses and organizations, the ramifications of ESC 18 run deep, as it applies to both amounts spent by entities in the period and amounts received from third parties. That said, it can present opportunities for redress in cases where entities have been over capitalizing costs, or simply need to restructure or re-evaluate their capitalisation process.
For some organisations, identifying eligible R&D may prove difficult, which may place strain on budgets. For others, there may be an avenue to seek a reprieve thereof; in that circumstances of genuine financial distress are at play. In its May 2022 release, "R&D Administration – Escalating Corporate Costs" ASIC recognised this (see from page 15). It also recognised a potential trend of R&D entities being ill-equipped to manage the impact of ESC 18.
Non-controversial accounting errors, however minor, must be corrected; the effect of the new standard is retroactive and organisations are required to apply the changes from the beginning of the financial year that starts on or after 22 June 2016. Significant adjustments may be difficult to manage without expert assistance in remedial and grievance procedures. The correct accounting treatment must be established in accordance with both ESC 18 and AASB standards, the result of which may have serious consequences for many. For example, there will potentially be a number of R&D tax incentive claimants facing tax liabilities for 2017-2021 after being able to successfully claim previously.
Organisations in the unfortunate position of being impacted negatively by the new standard, may consider submitting a grievance requesting a decision maker to make a choice of cost accounting method or principal activities test, where there are deemed difficulties or unreasonable hardship under section 25 of the AAT Act. There are limits whether the test is satisfied, otherwise the Federal Courts may find the decision-maker made an error. In the event an application in relation to a failure to exercise a discretion, there can be argument put forward that the discretion had to be exercised in a particular way, which must be done taking into consideration the public interest.
For those organisations who are actually better off under the new standard, or simply do not have the nerve to pursue any appeals, it is recommended that they be carefully assessing their risks and reporting accordingly under AASB 108 – Accounting Policies, Changes in Accounting Estimates and Errors. For some, it may even present opportunities in the investment market. Without careful assessment however, what seems like minor adjustments may be costly.
Recent Cases Adjudicating ESC 18
One of the most significant impacts of ESC 18 has been an explosion in the number of transactions that, prior to 1 January 2017, were disclosed as separate lease and leasing related service contracts but that, given the right structuring, are now able to fall under a single contract (a "Bundled Contract"). Bundled Contracts avoid the need for separate accounting of the asset and liability for the lease element of the arrangement, whilst also avoiding any potential lumpiness or imbalance that would have arisen in respect of a single or separate leasing related service contracts. As noted, our experience is that, given the ease by which ESC 18 permits the unbundling of the various components of a proposed arrangement, ESCA is regularly asked to unbundle proposed arrangements for the purposes of determining whether they constitute a lease and / or are in any way impacted by the provisions of ESC 18. Below are just two examples of such requests to unbundle proposed arrangements.
ESCA was recently approached to undertake an analysis of two proposed, almost identical , arrangements for the lease and leasing related services of certain equipment at two mining facilities. In both cases the critical issue was whether the core of the arrangement was in fact a lease or other form of leasing related service contract. ESCA was also requested to undertake a high-level analysis of where the economic risks lie in the event of the assets remaining / not remaining in place at the end of the term. After a detailed review and unbundling of both arrangements, ESCA concluded that the core of each arrangement was in fact a lease and the most appropriate accounting treatment was to treat the two contracts as one single arrangement in which the leasing related service was ancillary to the leasing of equipment. Similarly, ESCA was recently called upon to prepare an analysis, unbundling two contracts in respect of the provision of telecommunications and connectivity services at the Sede BndL in Maputo. The contracts were structured such that they were to payable quarterly in advance. The question was whether / how those payments should be allocated so that the lessor and lessee would each recognise their respective revenue and expense on a straight-line basis over the term of the contracts.
What’s Next in ESC 18
Looking ahead, the provisions of ESC 18 are likely to continue evolving alongside other industry and regulatory changes. One of the key trends is probably the CCAR disclosure rule. The disclosure rule applies uniformly to the disclosures of a bank holding company, savings and loan holding company, or state member bank (or any affiliate thereof) that are subject to a stress test under the capital stress testing rules, including the qualitative and quantitative capital plans or stress tests mandated by Dodd-Frank. For these purposes, the qualitative and quantitative capital plans and stress tests are those mandatory capital plans or stress tests conducted under stress-testing rules, which in turn would include the CCAR capital plan rule and any mandatory capital plan required under 12 U.S.C. § 5365(a)(2), as well as any associated periodic submissions of reports. The disclosure rule provides that the scope of required disclosures will encompass the information used in the preparation of the report that is the subject of the disclosure, including all material information concerning: These disclosures are designed to ensure that investors and other market participants have access to comprehensive disclosure of risk issues affecting general operations and management, and its expected impact on performance and position. It is to be noted, however, that analysts may need to become proficient in navigating both the ESC and CCAR "language" due to certain regulation-specific terminologies. These expected future developments will impact the way that law firms prepare and craft disclosure documents and what kinds of information are essential for clients to provide.
Final Observations in the Wake of ESC 18
In conclusion, the best way to navigate and remain within ESC 18 is to ensure that you are fully aware of all the requirements under the framework. As outlined above, this basically means: It is extremely important to ensure that both the licensee and the customer are aware of their responsibilities and to make it clear to them that by signing the contract they are agreeing to both parties strictly adhere to the requirements of ESC 18 . The customers in particular are likely to be wholly unaware of these requirements, so deepening their understanding and appreciation of their responsibilities is advantageous to ensuring compliance with ESC 18. These steps should be at the forefront of any licensee’s mind when it comes to continuing to operate and remain within the ESC framework.
